Hall v. Meisner: An Overreach of State Tax Collection Activity

This week, guest blogger Anna Gooch of the Center for Taxpayer Rights returns with a post about a fascinating 6th Circuit case dealing with the seizure powers of states and the Constitution’s Takings Clause.  Anna has been coordinating the Center’s nationwide survey of state taxpayer rights as well as the Center’s current workshop series, Reimagining Tax Administration: State Tax Practices & Taxpayer Rights.  All of us tax folks who only focus on federal tax controversies should especially read on – state tax practice is fascinating!  — Nina Olson

Federal tax practitioners are frequently reminded of the awesome powers the United States is given as a super-creditor – federal tax liens apply to all of a taxpayer’s interest in present and future property, and the reach of levies is much more expansive than that of private creditors. With the strength of the federal government a seemingly ever-present concern for taxpayers (exacerbated by politicians and the media), the ability of state and local governments to wreak havoc on taxpayers’ lives can easily slip through the cracks. Perhaps due to balanced budget requirements and limited scrutiny from practitioners and oversight groups, state governments are free to exercise their power with impunity – usually. In one recent case, the Sixth Circuit held that a Michigan law allowing strict foreclosure in the case of overdue property taxes oversteps not only the U.S. Constitution, but also the limitations established by over 800 years of legal precedent.

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The four plaintiffs in Hall et al. v. Meisner et al. each owned property in the city of Southfield, Oakland County, Michigan. When each owner failed to pay the property tax due, the county initiated foreclosure proceedings pursuant to the Michigan General Property Tax Act. The county then conveyed the properties to the city for the amount of the overdue tax (plus penalties and interest). In turn, the city transferred the properties to a for-profit entity for a nominal amount. This entity then sold the properties at fair market value. At no point during any of these transactions did any of the plaintiffs receive a refund of the equity they had in their property. The General Property Tax Act permits this. When a Michigan government entity is the creditor, as it is in the case of property tax, the government can pursue “strict foreclosure,” where the government receives absolute title to the property without a sale. The plaintiffs then sued, claiming that this practice violates the Takings Clause of the 5th Amendment.

Before I discuss the court’s explanation of why Michigan’s actions here violated the Takings Clause, an explanation of the Michigan General Property Tax Act is warranted. I found that the process set out in the act is best understood with a timeline.

  1. March 1, Year 1: Overdue property tax assessed in Year 0 becomes “delinquent.”
  2. March 1, Year 2: The county may begin foreclosure proceedings. If the county chooses not to, the state may initiate the foreclosure instead.
  3. June 15, Year 2: The county (or the state) must file a petition for foreclosure. The property owner is notified of their right of redemption.
  4. March 31, Year 3: A judgment for foreclosure is entered, giving the county (or the state) absolute title to the property.

Assuming the county is the foreclosing entity, the state has right of first refusal to purchase the property at either fair market value or the value of the tax due, whichever is greater. If the state declined this right, the city or locality in which the property is located could purchase the property for the amount of the tax due. The entity that ends up owning the party, whether the state, county, or city, is then permitted to conduct a public sale of the property. The original property owner is never entitled to receive a refund of their equity in the property. 

The court found that Michigan violated the Takings Clause by writing the General Property Tax Act by “defining away” the property interest that the plaintiffs had as equitable title. By ipse dixit (shoutout to my high school Latin teacher), Michigan wrote the law in such a way that ensures that the Takings Clause does not apply. According to the state and the district court, “The foreclosing governmental unit – the County – had not obtained any surplus at all from its disposition of the plaintiffs’ homes, because it conveyed them (to the City of Southfield) for merely the amounts of their tax deficiencies.” Because the General Property Tax Act allows strict foreclosures when the government is the party that initiates the foreclosure, the equitable title to the property is transferred with the legal title when the county (or state) receives absolute title to the property. Thus, there is no remaining property interest to take. Citing the U.S. Supreme Court, the Sixth Circuit finds that “a State may not sidestep the Takings Clause by disavowing traditional property interests long recognized under the law.”

So, which traditional property interests did Michigan disavow? The court readily found the practice of strict foreclosure afforded to government entities violates hundreds of years of British and American legal principles. Beginning with the 12th century introduction of mortgages into European law, the court emphasized that throughout history, the unilateral elimination of equitable title was considered “an intolerably harsh sanction.”  Before the practice of foreclosure by sale became the standard, courts (and the drafters of the Magna Carta) recognized the importance of reimbursing a defaulting property owner for the loss of the value of the property to the extent the value exceeded the debt. One solution to this was (and remains) the right of redemption given to property owners. For European courts, a mortgage was just a mortgage, just as a debt is just a debt – there is no inherent right to additional equity that accompanies either.

American courts agreed with their European predecessors. Describing the history, the Hall court writes that “American courts were uniformly hostile to strict foreclosure” where absolute title was awarded to the creditor, citing cases that found the practice “unconscionable” and with “no appropriate place” in a legal system where a default on a mortgage or debt does not convey legal title to the creditor. To satisfy the competing interests of the creditor’s interest in its security and the landowner’s equitable interest, American courts – including those in Michigan — almost uniformly adopted foreclosure by sale, which was generally required to be public. The practice of foreclosure by sale extended not only to mortgages, but also to tax debts. The U.S. Supreme Court firmly agreed with this position. Holding that a creditor is entitled only to the value of the debt owed, “a tax collector had ‘unquestionably exceeded his authority’ when he had sold more land than ‘necessary to pay the tax in arrear.’” Put bluntly, “According to the long-settled rules of law and equity in all the states whose jurisprudence has been modelled upon the common law, legal title to the premises in question vested in the creditor upon the debtor’s default, yet the landowner still held ‘equitable title’ to the property.”

Though the Hall court does not discuss federal foreclosure procedures, it is important to note the difference between the government foreclosure process in the Michigan Property Tax Act and that in federal law. The law governing IRS foreclosures and the proceeds from those foreclosures conforms with the centuries of European and American law discussed in this case because it requires that the IRS return any remaining equity to the taxpayer-owner. Moreover, it mandates that the IRS take additional steps before allowing seizure and sale.  Both the Internal Revenue Code and the IRM provide that in the event that there are excess proceeds from the sale, those proceeds should either be returned to the property owner or given to junior creditors, whoever is entitled to them under the applicable state law. This is the key difference, and one that protects taxpayer rights in a way that the Michigan law does not. Regardless of whether the IRS chooses to pursue an administrative foreclosure or a judicial foreclosure, there are several steps that must be taken before the action can begin. Indeed, foreclosure must be a last resort for the IRS where other collection mechanisms have failed. Christine discusses what proving this involves here. Additionally, the IRS must give notice not only to the property owner, but also to those who occupy the property. The IRS’ procedures for initiating and conducting a foreclosure sale are not perfect, as discussed by the Taxpayer Advocate here, but they are in line with centuries of law designed to protect property owners and their equitable interest in their property.  

Equitable title arises before a sale or other transfer; in not holding a public sale, Michigan ignores rather than extinguishes equitable title when the government initiates foreclosure proceedings in response to unpaid tax debt. Internationally, there is a rich history in this area, with near unanimity in the conclusion that strict foreclosure improperly discards the owner’s equity in their land. Michigan’s General Property Tax Act and the lawsuit that followed are just one example of the power that state governments have when collecting tax debts and the importance of advocacy to keep this power in control and to protect taxpayer rights at the state and local levels.

Consequences of the (Fake) Notice of Intent to Levy

At the recent Fall ABA meeting there was a panel discussing Collection Appeals (which Christine was a panelist on). A discussion arose about the purpose of the CP504 “Notice of Intent to Levy,” since it is not a “real” notice of intent to levy for IRC § 6330 purposes. It is, however, a “real” notice of intent to levy for IRC § 6331(d) purposes… but what is the distinction, and when does it matter?

I have historically looked at the CP504 as little more than an IRS scare tactic strongly encouraging voluntary payment. My view has since changed, thanks in part to the ABA meeting. In this post, I’ll talk about the importance of the CP504 and why the language on the notice does such a bad job of explaining what actual legal consequence it carries that it almost shouldn’t carry legal consequence at all.

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This is not the first time Procedurally Taxing or the tax community at large has weighed in on the problems of the CP504. Keith posted about how misleading the notice is back in 2016. The main issue Keith raised was that the CP504 misleads people into thinking that if you don’t respond to the CP504 Notice the IRS can levy on things that it cannot levy on (yet).

In other words, it misleads people.

The IRS heard Keith’s complaint, and admirably took some steps to remedy the issue by changing the language of the CP504 Notice a few years later. Keith posted about this small step forward with a copy of the new CP504 Notice back in 2018.

Flash forward to present day, and a newly formatted CP504 Notice…

I don’t exactly know what decisions were made, but we appear to be back in the bad old days Keith had originally lamented. My clients routinely receive CP504 Notices like the one here. The offending language is exactly what Keith had highlighted before:

Consequences If You Don’t Pay Immediately

We may levy your income and bank accounts, as well as seize your property or rights to property if you fail to comply. Property includes wages and other income, bank accounts, business assets, personal assets (including your car and home), Social Security benefits, Alaska Permanent Fund dividends, or state tax refunds. [Emphasis in original]

Now I am but a humble tax lawyer and professor, but in reading this I can imagine someone concluding that failing to pay the IRS immediately upon receiving the CP504 means that the IRS could levy their income and bank account. Those are the bolded terms, after all. However, because I also know that to be untrue (the IRS cannot levy on my bank account and wages if I don’t respond to the CP504), I have tended to read the notice as being little more than a scare tactic and carrying no real legal consequence. My misunderstanding about the CP504’s consequences are in no small part because the consequences the CP504 focuses on so boldly are incorrect.

Actual Legal Consequences

But the CP504 actually does carry important consequences, such that it is a letter you should actually pay close attention to. The consequences it carries are so simple, it is a shame that the letter doesn’t really highlight them:

First, the CP504 is the notice that allows the IRS to levy on certain property prior to offering a CDP hearing. For my clients that is almost exclusively their state tax refunds. The CP504 mentions this in very small print at the bottom of page 2. The full list of pre-CDP Notice levy property is at IRC § 6330(f). I always knew the IRS could levy on state tax refunds prior to giving a CDP hearing, but admittedly never really considered the CP504’s role in that process.

Second, and generally less importantly, the CP504 notice bumps up the “failure to pay” rate from 0.5% per month up to 1%. See IRC § 6651(d). This is generally less important for my clients because the maximum amount of penalty cannot exceed 25% in the aggregate, and a lot of very late tax years hit that mark quickly. Also, most of my clients are able to settle their tax debts with an Offer in Compromise, such that penalties are irrelevant.

With Legal Consequences Comes… Legal Consequences

So now, despite the CP504 Notices best efforts, we have a clearer idea of what the CP504 Notice actually does. But what happens if the CP504 Notice is defective? Because it serves an actual, legal purpose, defects may carry actual legal consequences.

As Keith noted in his prior post, the IRS used to combine the IRC § 6331(d) notice and IRC § 6330 CDP opportunity into a single letter. Now those two statutorily required notices are “spread” across two letters. This may be a self-inflicted wound by the IRS. For one, an extra letter adds real costs to the IRS: both the 6331(d) and 6330 notices are supposed to be sent certified. Arguably having two (required) letters instead of one essentially doubles the IRS’s chances of screwing up.

Possibly, the IRS could argue that the current IRC § 6330 letter (usually, the LT11) also meets and incorporates the IRC § 6331(d) requirements, such that it current practice is really a belt-and-suspenders approach. In other words, a bad CP504 letter would be “fixed” by the later LT11 letter. I don’t know that this argument has ever been raised. But even if it was, it would certainly not prevail for levies that precede the LT11 (for example, state tax refunds). Accordingly, the issuance of the CP504 Notice remains worth looking into.

For a CP504 Notice to meet the IRC § 6331(d) requirements it must be sent (by registered or certified mail) to the taxpayers last known address no less than 30 days before the levy. I somewhat doubt that any such letter that isn’t sent certified/registered would be considered invalid. (I couldn’t find any freely available cases, but U.S. v. MPM Financial Group, Inc. (2005 WL 1322801, at *4 (E.D. Ky. May 27, 2005) aff’d, 215 F. App’x 476 (6th Cir. 2007) makes that point. The real issues are timing and address concerns.

Beginning with the last known address: this has primarily been an important topic on deficiency notices for some time (see posts here and here, among others). There is always a chance (perhaps a significant chance, given the IRS’s IT infrastructure) that the IRS will send a notice to the wrong last-known address. In such a case if the taxpayer doesn’t otherwise have actual knowledge of the notice, it should invalidate the CP504 Notice from serving its IRC § 6331(d) “notice” function.

What happens after a defective CP504 Notice has been mailed may be interesting. If the IRS levies on your state tax refund you will thereafter get a “Notice of Intent to Levy” under IRC § 6330. In my experience, a lot of time the IRS will send a CP504 Notice well in advance of actually taking any other collection actions, such that they may have had the wrong address in their file for the CP504 Notice, and then have corrected it by the time of the actual state tax levy.

If the state tax refund levy was improper because there was no valid IRC § 6331(d) notice preceding it, arguably you should be returned the state tax refund proceeds. That, at least, is the argument I’d make in the CDP hearing: the IRS plainly did not follow “the requirements of any applicable law or administrative procedure” in taking the refund. Accordingly, you should get it back: a very important potential remedy, given the limitations on refund jurisdiction in Tax Court. This matters enough to many of my clients (Minnesota income tax returns have some lucrative refundable credits) that a detailed review of the CP504 Notice validity is warranted.

My Plea: Make the Letter Useful

Again, the CP504 really only carries two legal consequences: (1) precursor to levy on very specific property (that might not matter at all to people in states without an income tax) and (2) increase the failure to pay penalty rate. If the goal of the notice is to inform people about the legal consequences of being issued a CP504 notice it does a tremendously bad job of it. Instead it reads like a scare tactic.

Perhaps this serves a useful function for the IRS in getting some people to voluntarily pay, but I think it comes at a reputational cost, and scares people into sub-optimal resolutions. A lot of my clients receive state tax refunds each year (particularly state property tax refunds) which they count on. A lot of my clients also are very clearly “can’t pay” candidates for an Offer in Compromise or Currently Not Collectible status.

The IRS’s mission isn’t simply to “get the most money” out of people. If it was, then the CP504 Notice would probably be justified. Rather, the IRS’s purported mission is to “Provide America’s taxpayers top quality service by helping them understand and meet their tax responsibilities[.]” It is hard to see a misleading letter as “helping them to understand,” and I’d say the CP504 is an example of straying from that mission.

TIGTA’s Annual Review of CDP Processing     

It’s the time of year when the Treasury Inspector General for Tax Administration (TIGTA) starts producing the annual reports required of it by the Restructuring and Reform Act of 1998.  It recently produced its report regarding the Collection Due Process program.  The report is short. 

To produce the report, TIGTA looked at a sample of CDP and Equivalent Hearing cases designed to produce a picture of CDP performance with a 95% accuracy rate.  This year it reported that in FY 2021 there were 28,667 CDP and Equivalent Hearing cases closed.  It sampled 91 of those cases finding that “Appeals complied with most of the I.R.C. and Internal Revenue Manual 8.22.4, Collection Due Process Appeals Program (May 12, 2022), requirements for processing hearing requests.”

The one area where TIGTA dinged Appeals, an area where it has dinged Appeals before and we have discussed before, here, here and here, concerned the statute of limitations on collection (CSED).  TIGTA found that in 20% of the reviewed cases the IRS got the CSED wrong.  In 10 of the cases it got the CSED wrong in a way that incorrectly extended the statute of limitations.  Based on this sample, it projected that 3,233 of the CDP and Equivalent Hearing cases closed in 2021 would have incorrect CSED in which the IRS sought to collect from taxpayers after the CSED expired.  This is way too high an error rate and it’s not the first time a high CSED error rate has been reported.  The IRS has got to learn how to calculate the CSED.

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TIGTA found that in 8 cases in its sample the IRS miscalculated the CSED in  a way that wrongly reduced the period the IRS had to collect.  It extrapolated that this meant 2,586 of the CDP cases closed in 2021 had the CSED shortened.  While shortening the CSED does not imping on the taxpayer rights of the individual taxpayer, it does mean that collectively the taxpayers of the United States may not have as much collected from people who owe.

Calculating the CSED is hard with the exceptions that currently exist and the way they operate.  If the IRS cannot get this right – and it has demonstrated over a relatively long period of time that it cannot – perhaps Congress should look at simplifying the process.  The most obvious place to simplify it would be to do away with the really confusing extension related to installment agreements.  Eliminating that statute extension would probably bring the IRS error rate down significantly but TIGTA does not provide us with an analysis of the mistakes that it found.  Had it done so, it would have provided the IRS and the public with a better roadmap for pursuing success.

TIGTA found that Appeals correctly classified CDP and Equivalent Hearing requests; however, it did so based on the criteria published in the IRM and not based on case law.  TIGTA does not address cases in which a taxpayer sends in a CDP request after the 30 day period based on a good excuse or sends the CDP to the timely but not to the office requested by the IRS.  Because it does not look for these types of cases, TIGTA misses an opportunity to assist the IRS in updating its outdated IRM provisions.  It audits based on what the IRS says and not what the IRM should say.

TIGTA also does not audit the CDP letter which does a poor job of advising taxpayers of their rights.  It might consider in future years looking at why the uptake rate of CDP cases is so low and how that relates to the notice received by taxpayers.

For this year we know that the Appeals, and the IRS generally, struggles with the CSED.  Looking for ways to fix that other than continuing to point to IRM compliance might provide an overall benefit to the system.

Prior Opportunity and Other Collection Due Process Information

At the Court Practice and Procedure committee during recent ABA Tax Section meeting there was a panel on Collection Due Process (CDP.)  The panel put up some statistics on CDP from a few years ago that I will put into this post.  It also discussed a 15 year old case precedential CDP case, Perkins v. Commissioner, 129 T.C. 58 (2007) to highlight the narrow path it presents for obtaining a hearing on the merits of the underlying tax in contrast to most prior opportunity cases.  The panel also discussed the very recent case of Jackson v. Commissioner, T.C. Memo 2022-50 regarding the issue of variance in CDP cases.  In addition to providing the statistics, I will discuss the two cases.

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The first slide depicts the number of CDP cases filed in the past two fiscal years:

The second slide provides data from 2018 regarding the percentage of taxpayers who make CDP requests:

The third and fourth slides provides information about the taxpayers most likely to make CDP requests:

In addition to discussing characteristics of typical CDP petitioners, the panel discussed the narrow path to getting the Tax Court to look at the merits of an assessable penalty provided by the Perkins case.  As we have blogged about in some depth, the Tax Court takes the view that having the opportunity to go to Appeals counts as a prior opportunity for purposes of determining if a taxpayer may raise the merits of the underlying liability in a CDP case.  Here is a link to a post discussing prior opportunity and linking to several other posts on this issue.  The concern arises regularly in assessable penalty cases such as the three cases Lavar Taylor took to the circuit courts and discussed in posts found in the linked post; however, it arises in other contexts as well. 

I find it unsatisfactory that a visit to Appeals qualifies as a prior opportunity.  Taxpayers had that type of opportunity prior to the passage of the CDP legislation.  Why would Congress have passed a statute giving taxpayers an opportunity to contest the merits of their liability that they already had?  The tenor of the statute seemed to be one of a broad exception to the Flora rule but which has now been interpreted to create a very narrow exception to the Flora rule and one which is almost impossibly narrow of the case of Lander v. Commissioner, 154 T.C. No. 7 (2020) is taken to its logical extreme since every taxpayer who does not receive their notice of deficiency has the opportunity to seek audit reconsideration.

A long introduction to reach the narrow exception provided by Perkins for obtaining a merits hearing in a CDP case.  In Perkins the IRS sent a math error notice and Mr. Perkins did not respond within 60 days allowing the math error assessment to stand without requiring the IRS to send a notice of deficiency; however, he appealed the increase in a letter that was forwarded to Appeal. While the case was pending in Appeals, the IRS sent a notice of intent to levy and he requested a CDP hearing in which he sought to contest the merits of the assessment.

Before Mr. Perkins had his CDP hearing, Appeals held a hearing on his original request treating it as a request for abatement and denying the request. In his CDP case Appeals declined to hear his merits request again stating he had a prior opportunity to contest it.  The Tax Court held that because his first request for an Appeals hearing was still pending at the time of his CDP request he had not had a prior opportunity.  The panelist at the ABA took the position that the same situation that faced Mr. Perkins could occur in other setting, such as assessable penalties, if the appeal of the merits of the assessable penalty was still pending at the time the taxpayer received the CDP notice.  Given the delays at Appeals caused by the pandemic, the chance that Appeals might take a long time to resolve an administrative appeal of an assessed liability may exist now to a greater extent than might ordinarily be true.

I don’t know how often collection of the tax gets out in front of an administrative appeal on the merits of an assessed liability.  Keeping Perkins in mind for those situation is important but may provide a benefit only in rare situations.

In the Jackson case the Court granted a summary judgment motion filed by the IRS.  In the Jackson case the taxpayers did not remit full payment with the return and the unpaid balance was high enough that the IRS filed a notice of federal tax lien (NFTL.)  The Jacksons did not file a CDP request in response to the NFTL.  They sought an installment agreement which the IRS rejected after which it sent a notice of intent to levy.  They did request a hearing in response to this CDP notice.  Petitioners sought an installment agreement in the CDP hearing; however, the Settlement Officer informed them that because they had failed to make necessary estimated tax payments their lack of compliance rendered them ineligible for this relief.  Appeals issued a notice of determination sustaining the proposed levy.

In Tax Court petitioners continued to seek an installment agreement but also abatement of interest and penalties.  The Court viewed this additional request as a variance from the issue raised in their CDP request.  It pointed to its prior decisions requiring taxpayers to raise issues with Appeals if they wanted to raise them with the Tax Court:

This Court considers a taxpayer’s challenge to an underlying liability in a collection action case only if he or she properly raised that challenge at the administrative hearing. Giamelli v. Commissioner, 129 T.C. 107, 115 (2007). An issue is not properly raised at the administrative hearing if the taxpayer fails to request consideration of that issue or if the taxpayer requests consideration but fails to present any evidence after receiving a reasonable opportunity to do so. Id. at 115-16; Gentile v. Commissioner, T.C. Memo. 2013-175, at *6-7, aff’d, 592 F. App’x 824 (11th Cir. 2014).

The Petition in this case appears to assign error to respondent’s assessments of section 6651(a)(2) additions to tax and statutory interest for the years in issue. However, respondent asserts that petitioners never challenged their underlying liabilities at the CDP hearing, and we agree. The record of the CDP hearing includes no evidence that petitioners challenged their liability for the additions to tax or sought an abatement of interest. Neither petitioners’ Form 12153 nor the attached cover letter references additions to tax or interest. Furthermore, SO Melcher’s case activity record indicates that Mr. Bolton specifically disclaimed a challenge to the assessments in issue during their telephone conference. According to SO Melcher’s notes, the only issue Mr. Bolton raised during their telephone conference was the rejected installment agreement. Petitioners have not set forth any evidence suggesting otherwise.

The Jackson case does not raise new issues. It merely serves as a reminder to raise all issues when requested a CDP hearing.

Dial, redial, repeat

We welcome back guest blogger Barbara Heggie. Barb is the supervising attorney for the Low-Income Taxpayer Project of 603 Legal Aid in Concord, New Hampshire.  Her clinic serves taxpayers through the Granite State and is the only LITC in the state.  Today, she describes a recent experience in trying to assist a client.  Her effort reminds us of the difficulties facing taxpayers and practitioners trying to reach the IRS in the first place and trying to reach the “right” part of the IRS.  We recently discussed one of the impediments to reaching the IRS in our post on fee based calling which pushes human callers to the back of the line. Keith

Most people think of the autonomic nervous system as confined to such unconscious bodily processes as breathing, digestion, and heart rate. But most of you reading this have probably added another to the list – (re)dialing the IRS. Pandemic-related staffing shortages, antediluvial technology, and a private robocalling industry have teamed up to render uncertain the once-inviolable privilege of being placed on hold for an hour. Instead, any attempt to reach the IRS by phone, even via the Practitioner Priority Service (PPS), will likely end with this now-familiar recording: “We are sorry, but due to extremely high call volume in the topic you requested, we are unable to handle your call at this time.” A new callback option can spare us the slow torture of short-looped, wondrously-insipid hold music, but it can’t spare us the agony of trying to get there.

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Dial, redial, repeat.

This is all the more agonizing when we realize that a few well-placed, taxpayer-centric changes at the IRS could make this time suck a complete non-necessity. The National Taxpayer Advocate (NTA), Erin Collins, has written here and here about the robocalling problem and the low levels of telephone service at the IRS. And see here for several seemingly doable suggestions regarding economic hardship and collection processes by former NTA Nina Olson in her 2018 Annual Report to Congress.

Last week, I called PPS for a disabled domestic violence survivor subsisting solely on $1,020/month in Social Security Disability Insurance payments. She has a joint tax liability with her estranged husband, and she’s terrified he’ll get to her through the IRS. Each new collections notice sent her to the phone, anxious to explain her circumstances and request some sort of forbearance. But she couldn’t get past the “extremely high call volume.”

She came to me for help, and we decided I would start by asking the IRS to (1) record her balance-due accounts currently not collectible, due to financial hardship, and (2) place a domestic violence marker on all her accounts to prevent the IRS from releasing any of her contact information to an unauthorized person, including her husband. Conceivably, each of these requests could be made in writing, but much harm could come to this client while waiting for the IRS to process such submissions. A call to the IRS was required.

After dialing PPS sixteen times, each attempt involving a must-listen to various recorded messages, I made it onto the queue. Huzzah! I readily agreed to the callback option and got connected to a customer service representative (CSR) a half an hour later, just as promised. He placed a Victim of Domestic Violence (VODV) marker on my client’s accounts but said he could not record her balances uncollectible. I was surprised, given that I had chosen the menu option for “individual accounts already in collections, ACS.” Moreover, for balances at my client’s level, the Internal Revenue Manual requires no Collection Information Statement (CIS) if the only source of income is Social Security. But there had been a change in procedures, the CSR explained, and he offered to transfer me to the “real” Automated Collection System (ACS), where someone could do as I had requested.

Rather than have him transfer me, however, I decided to call PPS again – not because I thought a different CSR would give me a better answer, but because this one wasn’t able to send me the transcripts I wanted due to some equipment failure he was experiencing, and I wasn’t sure an ACS CSR would have the authority to do this. I hadn’t been able to retrieve the transcripts myself from the IRS Transcript Delivery Service (TDS) because . . . I don’t know. The CSR affirmed I had been listed on the accounts as an authorized representative for several days, but TDS said otherwise and refused to give up the transcripts. (This doesn’t appear to be an isolated incident; recently, many others in the Low-Income Taxpayer Clinic community have reported the same problem.)

Thus, I called PPS again.

Dial, redial, redial,

redial, redial, redial,

redial, redial, redial,

redial, redial, redial.

Just twelve times! The second PPS CSR got me the transcripts but said the same thing as the first one; the CNC request can only be handled by ACS personnel, no matter the circumstances. (A week later, TDS is still denying me access to these accounts.)

The CSR offered to transfer me to ACS, and this time I agreed. After a few minutes, another CSR picked up the line, and I made my simple pitch: please record my client’s balance-due accounts as uncollectible because her only income is Social Security and she’s experiencing financial hardship. This CSR, #3 of the day, said he couldn’t see any debt under my client’s SSN – and, therefore, couldn’t help me. I stressed it was a joint liability, with my client listed as the secondary on the account. The CSR responded that this explained the problem and asked if I had any other questions. Telling him that the previous two CSRs of the day hadn’t had any such problem left him unfazed. When he suggested transferring me to “Collections,” I agreed, not bothering to ask where I had been the whole time.

The beauty of a unit-to-unit transfer is that you bypass the hold queue and go straight to a CSR picking up your line. At least, that’s how it used to be. This time, it took over two hours – the longest hold time I’ve ever encountered. Luckily, however, CSR #4 of the day was able to both see and do. I made my pitch for uncollectible status and explained the client’s income stream. The CSR verified the Social Security income, found no other sources, and granted the request for uncollectible status. As expected, she didn’t require a CIS. And by then, it was bedtime.

Fans of the Python-esque film Brazil may find some commonalities.

What are the Most Litigated Issues and What’s Happening in Collection?

This year the National Taxpayer Advocate took a new approach to calculating the most litigated issues in her annual report.  You can read about her approach starting on page 183 of the report.   Instead of just looking at the tried cases, which she does capture, she also looks at the cases in which taxpayers filed a Tax Court petition.  It’s all in how you define litigation.  Is it best measured by the relatively small number of cases that get tried and receive an opinion, i.e., looking at the end of the case where about 1% of the filed cases end up, or by looking at the filed cases in which taxpayers started litigation but for a variety of reasons did not follow it to a conclusion by trial and opinion?  Since she gives you both sets of data, it’s hard to complain no matter which set of information you prefer.

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Here are the charts, with the first one based on opinions issued and the second one on petitions filed:

Some things come out the same in either measure as the report states:

[Gross income disputes] was the number one issue among those litigated in the Tax Court with 66 substantive opinions issued. It was also the largest category of cases petitioned to the Tax Court. In FY 2021, taxpayers petitioned the Tax Court in 13,558 cases where gross income was an issue during the examination.

In the same vein, trade or business disputes came in second under both methods:

50 opinions where this category of issues was litigated in the Tax Court. Taxpayers petitioned the Tax Court in 2,255 instances where trade or business expenses were an issue during the examination in FY 2021.20 This category is high on our list as the second most prevalent category of opinions issued at the Tax Court and the second most petitioned issue in the Tax Court.

Collection due process notices and hearing requests continue to fall.  Some of the falloff in the most recent period is no doubt attributable to the pandemic, but the trend was set before Covid arrived.  Here is a graph displaying the trend:

The report gives more details and explanations for those interested.  It also included a chart on the number of family status cases petitioned to the Tax Court.  The number of Earned Income Tax Credit (EITC) cases seems low when you read about the number of EITC audits.

This section of the report also contains an analysis of the number of non-Tax Court cases litigated during the past year.  Even more than the CDP filing chart above, a chart showing the number of lien cases referred to the Department of Justice shows a precipitous decline.  Perhaps, the decline should come as no surprise given the decline in revenue officers over this period.  Without revenue officers to initiate these cases, there can be no referrals to DOJ.  The number is getting close to approaching zero which is bad news for tax administration.  Again, of course, the pandemic plays a role, but the slide started before the pandemic arrived.

This is a good time to mention an excellent article recently published in Tax Notes regarding collection or the need for more resources at the IRS in order for it to engage in meaningful collection efforts.  Attached is the article.  The decline in suits is more than matched by the decline in liens, levies and seizures.  The chart below shows the amazing decline in these activities.  This chart shows not only the recent drop off as a result of the pandemic but also the 10-year decline as the IRS’ resources were squeezed by Congressional budgetary action.

No big surprises that the IRS is struggling in its enforcement efforts, that these efforts have declined significantly over the past decade or that they declined significantly during the pandemic.  Still, a pretty bleak picture of the IRS’ ability to pursue meaningful collection action when needed.

Disclosure of Collection Activity with Respect to Joint Returns

It’s the annual season for the reports from TIGTA mandated by Congress in 1998 and never unmandated.  So, each year TIGTA dutifully expends its resources on the problems Congress was concerned about in 1998, whether or not anyone is concerned about those issues today.  Some of the issues on which TIGTA writes its reports show that the IRS has persistent problems which, year after year, it cannot seem to fix.  One of the areas on which TIGTA reports annually and which the IRS cannot seem to fix is disclosing information on joint returns.  I wrote about this topic in 2020 and I wrote about this topic in 2018 when the annual TIGTA reports were released.  I probably sound like a broken record by writing on the topic this often, but the IRS needs to train its employees so they understand how the law works. 

Congress recognized that in certain situations the collection of a taxpayer’s liability is tied to payments potentially made by others.  In these situations, prior to the change in the law creating an exception to the disclosure laws and allowing the IRS to provide information to jointly liable parties, it was impossible to obtain information about payments from those jointly liable parties.  The TIGTA report shows that it can still be a practical impossibility to obtain this information, even though Congress opened the door allowing those jointly liable to learn of payments made, or not made, by the jointly liable person.

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The most recent TIGTA report on IRS compliance with the law allowing taxpayers access to information on joint accounts suggests that taxpayers still struggle to obtain this information.  The IRS continues to experience difficulties when it sets up mirrored accounts.  Read the prior post from 2020 linked above if you are unfamiliar with mirrored accounts.  These accounts create difficulty for the IRS and taxpayers alike who do not understand when they exist and how they operate.  Here is the primary finding of this year’s report, which sounds much like the primary finding from each of the last five years:

We reviewed judgmental samples of 124 Accounts Management case histories and 20 Field Assistance case histories documented in the Account Management Services system related to joint filer collection information requests in the W&I Division.7 Based on our review, we determined that employees did not follow the joint return disclosure requirements in 26 (21 percent) of the 124 Accounts Management customer service representatives’ history files and three (15 percent) of the 20 Field Assistance individual taxpayer advisory specialists’ history files. The 29 cases were errors because employees did not provide the requested collection activity to the divorced or separated spouse as required by law. In most cases, employees incorrectly stated that they could not provide any collection activity on the other joint taxpayer, such as whether the other taxpayer made a payment or the current collection status, because the taxpayers were no longer married nor living together. As a result, these 29 taxpayers or their representatives were potentially burdened with additional delays in resolving their respective tax matter. This has been a recurring issue for the last five years and we have made recommendations for the respective IRS business units we have reviewed to update the IRM as well as to provide additional training to their employees. The IRS should continue to address this issue in its respective business unit IRMs that provide guidance to employees who may respond to taxpayer inquiries about a joint return matter.

We also observed that 10 (38 percent) of the 26 cases with disclosure errors in Accounts Management and all three of the cases with disclosure errors in Field Assistance had “mirrored accounts.” Mirroring a joint account sets up two accounts, one for each of the taxpayers. Establishing two separate accounts provides the IRS a means to administer and track collection activity unique to each of the taxpayers. Each taxpayer remains jointly liable for the entire debt; i.e., mirroring an account does not divide the liability in half. Because joint filer taxpayers remain jointly liable, the same collection information, when requested, on mirrored accounts should be disclosed to both taxpayers as would be disclosed on any other jointly filed return, except when the request is for unrelated personal information.

In addition to looking at case files, TIGTA interviewed IRS employees, with 8 out of 24 responding incorrectly regarding information that could be provided to a divorced spouse when the question involved a “regular” account and 15 out of 24 responding incorrectly when the question involved a mirrored account. 

Problems not only occurred when asking the employees questions regarding information that should be disclosed to the former spouse.  TIGTA asked the IRS employees questions that made it clear the employees would provide information they were not authorized to disclose, including:

providing information about the other spouse’s location, name change, or telephone number; information about the other spouse’s employment, income, or assets; the income level of the other spouse at which a currently not collectible module would be reactivated; or the bankruptcy chapter filed by the other spouse.18 When asked questions about a taxpayer who was divorced or separated, five employees (21 percent) of the 24 interviewed responded that they would disclose some of these prohibited items about the other spouse.

This year’s responses continue to point to disclosure of information regarding ex-spouses as a weak point for the IRS.  The law allowing some disclosure of information was enacted 25 years ago.  Almost all of the persons surveyed would have started work at the IRS after the law went into effect.  This is not a case of changes in the law creating confusion.  Yet, confusion continues to persist.

It’s not clear if the problem is that the employees need more training or better training.  The persistent existence of problems in this area which TIGTA identifies year after year should cause the IRS to change its method of training employees so that it can ensure compliance with the law both for the benefit of ex-spouses seeking information and employees trying to keep from violating disclosure laws.

BC 507(a)(8)(C) Priority Prevents Discharge under BC 523(a)(1)(A)

Last week I wrote about the case of Lufkin v. Commissioner, T.C. Memo 2021-71, in which the Tax Court ruled on the impact of filing bankruptcy on the statute of limitations.  In that post, I mentioned that Bryan Camp wrote about the case as part of his Lessons from the Tax Court series, which alerted me to the decision.  In that same post Bryan also wrote about Barnes v. Commissioner, T.C. Memo. 2021-49, which Judge Lauber decided on May 4, 2021.  As with the Lufkin case, Bryan has a good write-up, and he provides good bankruptcy background information.  I will try to add a little additional color to the case.

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The Barnes case shows what happens when a taxpayer goes into bankruptcy while still contesting a liability.  As taxpayers learn, the result does not favor the taxpayer in a situation in which the unresolved liability gets resolved after the bankruptcy filing and the resolution allows the IRS to assess an additional amount.  The Tax Court must work through the bankruptcy provisions to get to the correct result which it does as it demonstrates again that bankruptcy discharge issues can find their way into Tax Court decisions requiring the Tax Court judges to understand bankruptcy law as they rule on tax collection issues.

When Mr. and Mrs. Barnes entered bankruptcy, they were still waiting for the Tax Court to make a decision on their 2003 liability.  They filed the Tax Court petition in 2008 and tried the case in June 2009.  They had submitted their briefs in the case when, on July 26, 2010, before the issuance of an opinion, they filed a chapter 11 petition.  The filing of the bankruptcy petition stayed the Tax Court proceeding and would have caused the Tax Court judge working on the opinion in their case to hold onto the opinion.  While the automatic stay stops the Tax Court proceeding, I don’t know if Tax Court judges interpret it as stopping them and their clerks from working on the case, or if it just stops them from issuing an opinion.  My guess is the latter, but I have not spoken with a Tax Court judge about how strictly the Tax Court interprets the stay.  Perhaps the Tax Court judges interpret the stay to require them to completely stop working on the opinion until the stay lifts, or perhaps there is a split among the judges regarding how they interpret the stay when it comes into existence during the opinion-writing stage of a case.

In any event, the existence of the unresolved Tax Court case means that as to the liability at issue in the Tax Court, the debt in the bankruptcy court for that unresolved liability would receive priority status under BC 507(a)(8)(A)(iii) because the liability was not yet assessed but was assessable. Here, the Barnes filed a chapter 11 case, which requires in BC 1129 that they commit in their plan to fully pay all priority claims.  The IRS participated in the plan and filed a proof of claim; however, it failed to include in its claim the 2003 liability.  The Barnes could have filed a claim on behalf of the IRS for 2003 or could have included 2003 in their plan, but the plan did not include the 2003 liability.  It’s hard to know whether this was oversight by one or both of the parties or a calculated decision.  The Barnes may not have wanted to commit to paying the $50K or so the IRS thought was due and may have been stretched to come up with a plan that would have paid it over time.  The IRS may have preferred to collect outside of bankruptcy and not lose the interest it would lose if paid through bankruptcy.  In any event, 2003 was not addressed.

Note that chapter 11 cases for individuals occur relatively infrequently.  If this were a chapter 11 filed by an entity, an oversight of this type could have ended the IRS’s hopes for any recovery on 2003 because of the super discharge available in chapter 11 to entitles.  That super discharge is not, however, available to individuals who must look to BC 523(a) for the discharge provisions and that’s where the Barnes lose their case with respect to the tax.

The chapter 11 plan, silent as to 2003, was confirmed.  The Tax Court says the automatic stay remained in place while the debtors made their plan payments.  In November 2011, the IRS filed a motion to lift the stay to allow the Tax Court case to move forward, which the bankruptcy court granted.  On April 2, 2012, the Tax Court entered its opinion.  Although the Barnes appealed the Tax Court opinion to the D.C. Circuit, they, like 99.9% of Tax Court petitioners who appeal, did not post a bond to stay assessment.  The IRS assessed on August 1, 2012.  The IRS eventually filed a notice of federal tax lien which allowed the Barnes to make a collection due process (CDP) request, which eventually led to the second Tax Court opinion regarding 2003 – this one only 18 years after the tax year, though the delay was not due to the Tax Court, which had acted reasonably expeditiously in both cases.

The Barnes’ first argument in the CDP case was that the 10-year statute of limitations on collection had ended before the IRS filed the notice of federal tax lien.  This argument makes absolutely no sense given that the assessment date for the 2003 liability is in 2012.  The Tax Court was gracious in noting that the collection statute remained open.

Next, the Barnes made another argument that made no sense – that the 2003 liability was discharged by the bankruptcy case.  Again, the Tax Court graciously pointed out that the liability was entitled to priority because it was not yet assessed but still assessable at the time of the bankruptcy petition.  Since they were represented, I am surprised by both arguments.

The Barnes requested an offer in compromise, but the IRS determined they had the ability to fully pay the debt.  Since they did not agree with that determination or did not want to pay the debt in full, the IRS determined the filing of the notice of federal tax lien was valid and the lien did not need to be released or withdrawn.  The Tax Court sustained this determination by ruling for the IRS in response to a motion for summary judgment.

Tax and penalty liability do not travel on the same discharge path in BC 523.  The penalty for late filing and the penalty for accuracy were discharged because they are governed by BC 523(a)(7) rather than 523(a)(1).  The provision for penalties essentially allows their discharge if three years has passed from the due date of the return at the time of the bankruptcy filing.  The Tax Court notes that these two penalties were discharged.  The interest on the penalties would likewise be discharged just as the interest in the tax would not.

Note that if the Barnes had owed taxes based on their return and not their deficiency case, the taxes owed which were shown on their return would have been discharged subject to an argument regarding the one-day rule, which the IRS would not raise and which the D.C. Circuit has not decided.  It’s possible for a taxpayer having liabilities that arise at different points in time to achieve different discharge results based on the timing of the liability vis a vis the timing of the filing of the bankruptcy petition.

If you have not read one of the many posts regarding the one-day rule, you can read one here which links to others.  The late filing of the 2003 return could itself have posed a basis for losing the ability to discharge any taxes due on 2003 had they filed bankruptcy in the 1st, 5th or 10th Circuits.  No one raised that argument in this case, and I mention it just because there was a late filing penalty assessed.