2021 Year in Review – Cases

December 28, 2021 by Leave a Comment

Despite the ability to access most courts only remotely for much if not all of the year, 2021 still produced a number of important tax procedure decisions.  Perhaps judges could produce more opinions because they did not need to travel or to hold lengthy in-person trials.  This post shows that not all cases are Graev cases.

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Supreme Court matters

The Supreme Court handed down a unanimous opinion in CIC Services.  The Court holds that the Anti-Injunction Act does not bar a suit challenging an IRS notice that requires a non-taxpayer to provide information even though the failure to provide the information could result in a penalty.  Posts can be found  here, here, here and here.

The Supreme Court rejected the request for certiorari in Organic Cannabis v. Commissioner seeking a determination that the time period for filing a petition in Tax Court in a deficiency case is a claims processing period rather than a jurisdictional one but granted certiorari in Boechler v. Commissioner regarding the same issue but in the collection due process context.  The Boechler case will be argued before the Supreme Court on January 12, 2022.

Circuit Court matters

Coffey v. Commissioner, –F.3d – (8th Cir. 2021)  – in a case that fractured the Tax Court about as badly as it can be fractured, the Eighth Circuit, after initially projecting harmony and uniformity in its decision, fractured as well, reversing its initial decision which overturned the Tax Court’s fully reviewed opinion.  This action briefly reopened the door on the question of adequate filing of a return for purposes of triggering the statute of limitations, before reinstating the original holding through a new opinion by the panel. That new panel opinion can be found here. 

Taxpayers claimed that they were residents of the US Virgin Islands in 2003 and 2004 and filed returns with the Virgin Islands tax authority.  That taxing authority has a symbiotic relationship with the IRS and sent to the IRS some of the documents it received.  The IRS took the documents it received and concluded that M/M Coffey should have filed a US tax return.  Based on that conclusion, it sent the Coffeys a notice of deficiency.  The Coffeys argued that the notice of deficiency was sent beyond the statute of limitations on assessment since their filing with the US Virgin Islands tax authority also served as a filing with the IRS, starting the normal assessment statute.  The government argued that because the Coffeys did not file a return with the US, no statute of limitations on assessment existed.  After only eight years, the Tax Court sided with the Coffeys.  A mere three years later, the Eighth Circuit reversed in a unanimous three judge panel. 

On February 10, 2021, the Eighth Circuit granted a panel rehearing but denied a rehearing en banc.  Disagreements with the outcome of a circuit court usually result in a request for a rehearing en banc rather than a rehearing with the very panel that entered the decision.  So, this is a bit of an unusual twist in a case with many twists. After the vacating of the original opinion, the same panel issued a new opinion with some minor differences.

The result of the Eighth Circuit’s decision allows the IRS to come in many years later to challenge residence of individuals claiming Virgin Islands residence.  If the Coffeys had succeeded in this case, the procedural issue would have turned into a substantive victory, since the IRS would not have been able to make an assessment against them for the years at issue.

Gregory v. Commissioner, — F.3d – (3rd Cir. 2020) – This case was decided at the very end of 2020 so it is included here as it came out during last year’s end of year review and also because it is a case argued on appeal by the Tax Clinic at Harvard so including it provides another opportunity to showcase the work of the students.  The issue before the Third Circuit was whether the taxpayers’ use of Forms 2848 Power of Attorney and 4868 Request for Extension of Time constituted “clear and concise notice” of a change of address to the IRS pursuant to Treasury Regulation §301.6212-2.  Although filed as a non-precedential opinion, the outcome is a clear example of how the IRS cannot simply ignore the actual knowledge it has of a taxpayer’s address when issuing a Statutory Notice of Deficiency pursuant to I.R.C. §6212(b)(1), even if that taxpayer failed to follow the IRS’ prescribed procedures for changing their address. 

An odd ending to this case occurred when the Third Circuit returned it to the Tax Court.  Rather than simply entering an opinion for the taxpayers, the Court issued an order restoring the case to the general docket.  That order made no sense because the Gregorys unquestionably filed their Tax Court petition late.  This required the filing of a motion to have the court make a determination that the notice of deficiency was invalid, which it eventually did with no opposition from an equally confused government counsel.

In Patrick’s Payroll Services, Inc., v. Commissioner, No. 20-1772 (6th Cir. 2021), the Sixth Circuit upheld the decision of the Tax Court denying the taxpayer the opportunity to litigate the merits of the underlying tax because of a prior opportunity to discuss settlement with Appeals.  Guest blogger Chaim Gordon wrote about this case after the Tax Court’s decision and while the case was pending before the Sixth Circuit.  Chaim pointed out some of the novel arguments the taxpayer was making.  Unfortunately for the taxpayer, the Sixth Circuit was not buying what they were selling.

The 11th Circuit upheld the decision of the Tax Court in Sleeth v. Commissioner, — F.3d — 2021 WL 1049815 (11th Cir. 2021), holding that Ms. Sleeth was not an innocent spouse.  The Sleeth case continues the run of unsuccessful taxpayer appeals of innocent spouse cases following the major structural changes to the law in 1998. The Tax Court found three positive factors and only one negative factor applying the tests of Rev. Proc. 2013-34.  Yet, despite the multitude of factors favoring relief in each case, the Tax Court found that the negative knowledge factor required denial of relief.  This case follows the decision in the Jacobsen case from 2020 in which the Tax Court denied relief to someone with four positive factors for relief and only knowledge as a negative factor.  The pattern developing in these cases suggests that the Tax Court views the knowledge factor as a super factor, despite changes in IRS guidance no longer describing it as such.  Only economic hardship seems capable of overcoming a negative determination on knowledge.  In this post, Carl Smith discussed the Seventh Circuit’s decision in the Jacobsen case.  Both cases were argued on appeal by the Tax Clinic at Harvard.  The clinic also filed an amicus brief in the case of Jones v. Commissioner, TC Memo 2019-139, set to be argued soon before the 9th Circuit.

Lindsay v. U.S. is the latest case to apply the principle that United States v. Boyle essentially stands for the position that taxpayers have a nondelegable duty to be aware of tax deadlines. An agent’s incompetence or willful misconduct will not excuse the taxpayer from delinquency penalties.  Lindsay was incarcerated and executed a POA to Bertelson, an attorney, to manage his affairs, including filing his tax returns.  The attorney assured Lindsay he was doing so for the years 2012-15; instead he failed to file the returns and for good measure embezzled hundreds of thousands of dollars. The actions resulted in Lindsay receiving $705,414.61 in actual damages and $1 million in punitive damages.  Lindsay eventually filed his tax returns and paid over $425,000 in delinquency penalties. He filed a claim for refund; IRS rejected and he filed a suit in district court. The district court, contrary to the magistrate’s recommendation, granted the government’s motion to dismiss, citing Boyle as precluding a claim for relief. Following a timely appeal, the Fifth Circuit affirmed. In so doing, it applied Boyle to Lindsay’s somewhat sympathetic circumstances.

Tax Court

In Ramey v Commissioner, 156 T.C. No. 1 (2021), the Tax Court determined in a precedential opinion that when the IRS issues a notice of decision rather than a notice of determination and the taxpayer has filed the collection due process (CDP) request late, the Court lacks jurisdiction to hear the case.  The taxpayer, a lawyer, represented himself and pegged his arguments to last known address rather than jurisdiction.  Nonetheless, the decision expands the Court’s narrow view of jurisdiction to another setting without addressing the Supreme Court precedent on jurisdiction and its impact on the timing of the filing of documents.

Galloway v Commissioner, TC Memo 2021-24: This case holds that a taxpayer cannot use the CDP process to rehash a previously rejected offer in compromise (OIC).  Mr. Galloway actually submitted two OICs that the IRS rejected.  As an aside, from the description of the OICs in the Court’s opinion, the rejections seemed appropriate strictly from an asset perspective, since he did not want to include the value of a car he owned but allowed his daughter to use. 

The case of Mason v. Commissioner, T.C.M. 2021-64 shows at least one benefit of submitting an offer in compromise (OIC) through a request for a collection due process (CDP) hearing.  As part of his lessons from the Tax Court series, Bryan Camp has written an excellent post both on the case and the history of offers. 

Friendship Creative Printers v. Commissioner, TC Memo 2021-19: This case holds that the taxpayer could raise the merits of delinquency penalties by the backhanded method of challenging the application of payments.  Taxpayer failed to pay employment taxes over an extended period of time and failed to file the necessary returns but at some point made payments on the earliest periods.  In the CDP hearing, taxpayer argued satisfaction of the earliest periods and eventually provided an analysis showing payments equal to the tax paid.

The Court treated this as a challenge to the merits of the delinquency penalties imposed.  Unfortunately, the taxpayer did not designate its payments, which meant that the payments it made were not applied in the manner it expected and argued in the CDP hearing.  Taxpayer also looked at the transcripts without appreciating the impact of accruals not reflected in the assessed portion of the transcript but accruing nonetheless.

Reynolds v. Commissioner, TC Memo 2021-10: This case holds that the IRS can collect on restitution based assessments even when the taxpayer has an agreement with the Department of Justice to make payments on the restitution award.  Taxpayer’s prosecution resulted in a significant restitution order. He agreed to pay DOJ $100 a month or 10% of his income.  At the time of the CDP case he was not working and did not appear to have many prospects for future employment. Citing Carpenter v. Commissioner, 152 T.C. 202 (2019), the Tax Court said that the IRS did have the right to pursue collection from him.  Obviously that right, at least with respect to levy, is tempered by the requirement in IRC 6343 not to levy when it would place someone in financial hardship, but no blanket prohibition existed to stop the IRS from collecting and therefore to stop it from making a CDP determination in support of lien or levy. The case is a good one to read for anyone dealing with a restitution based assessment to show the interplay between DOJ and IRS in the collection of this type of assessment, as well as to show the limitations of restitution based assessments compared to “regular” assessments.

BM Construction v. Commissioner, TC Memo 2021-13: This case involves, inter alia, a business owned by a single individual and the mailing of the CDP notice to the business owner rather than the business.  The Tax Court finds that sending the CDP notice to the individual rather than the business does not create a problem here, since the sole owner of the business would receive the notice were it addressed to the business rather than to him personally.

Shitrit v. Commissioner, T.C. Memo 2021-63, points out the limitations on raising issues other than the revocation of the passport when coming into the Tax Court under the jurisdiction of the passport provision.  Petitioner here tries to persuade the Tax Court to order the issuance of a refund but gets rebuffed due to the Court’s view of the scope of its jurisdiction in this type of case.

The case of Garcia v. Commissioner, 157 T.C. No. 1 (2021) provides clarity and guidance on the Tax Court’s jurisdiction in passport cases as the Court issues a precedential opinion to make clear some of the things that can and cannot happen in a contest regarding the certification of passport revocation.  I did not find the decision surprising.  The Court’s passport jurisdiction is quite limited.  Petitioners will generally be disappointed in the scope of relief available through this new type of Tax Court jurisdiction. 

Other Courts

In Mendu v. United States, No. 1:17-cv-00738 (Ct. Fd. Claims April 7, 2021) the Court of Federal Claims held that FBAR penalties are not taxes for purposes of applying the Flora rule.  In arguing for the imposition of the Flora rule, the taxpayer, in a twist of sides, sought to have the court require that the individual against whom the penalties were imposed fully pay the penalties before being allowed to challenge the penalties in court.  The FBAR penalties are not imposed under title 26 of the United States Code, which most of us shorthand into the Internal Revenue Code, but rather are imposed under Title 31 as part of the Bank Secrecy Act.

The case of In re Bowman, No. 20-11512 (E.D. La. 2021) denies debtor’s motion for summary judgment that Ms. Bowman deserves innocent spouse relief.  On its own, the court reviews the issue of its jurisdiction to hear an innocent spouse issue as part of her chapter 13 bankruptcy case and decides that it has jurisdiction to make such a decision.  The parties did not raise the jurisdiction issue, which is not surprising from the perspective of the plaintiff, but may signal a shift in the government’s position since it had previously opposed the jurisdiction of courts other than the Tax Court to hear innocent spouse cases.

Filed Under: Bank Secrecy Act, Bankruptcy, Collection Due Process, Designation of Payment, Employment Taxes, FBAR, Federal Courts - Jurisdiction, Form 2848, Innocent Spouse, Last Known Address, Offer in Compromise, Passport revocation, Penalty Application, Restitution, Statutes of Limitation, Tax Court

Designation of Payment in Payroll Tax Cases

August 12, 2021 by 6 Comments

We have not written about designation of payment in a long time.  Early in the life of the blog we had two posts on the topic which you can find here and here.  Designation of payment for any type of tax could have important consequences for the taxpayer and save lots of money.  For taxpayers who owe employment taxes, or any trust fund tax, or for responsible persons regarding those trust fund taxes, the issue of designation becomes more critical to a successful plan to limit liability.

The IRS allows taxpayers to designate the liability to which a payment is posted if the taxpayer or the person making the payment follows the correct steps.  Policy Statement 5-14 (found at IRM 1.2.1.6.3) sets out the basic policy governing designation of payments.  Essentially, the taxpayer, or the person making the payment, needs to clearly state the liability by tax type and period as well as describe what portion of the liability the person intends to pay, e.g., tax, penalty, or interest.  If properly designated, the IRS will take the funds and apply them in the manner requested by the taxpayer.

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Why does it matter which taxes get paid and what happens if a taxpayer makes a payment and does not designate?

It matters because sometimes a taxpayer owes different types of taxes and sometimes the taxpayer owes for several periods. 

Different taxes – Payroll taxes provide a good example of different types of taxes.  While you might lump payroll taxes together as one tax, it has different components.  Some of the payroll tax is owed because of the trust relationship created by the taxpayer when it withheld taxes from a third party for purposes of paying that tax over to the IRS.  Another part of the payroll tax is the taxpayer’s liability as a party making payroll to pay for the employer’s portion of payroll taxes.  Generally speaking, a payroll tax return (Form 941) will have three separate bases for liability.  Two are based on the trust relationship and stem from the money withheld from the employee to pay 1) income taxes and 2) Social Security and Medicare taxes.  The third portion of the payroll tax liability stems from the direct liability of the taxpayer to pay the employer’s portion of Social Security and Medicare taxes.

Different tax years – A taxpayer might owe income taxes for 2020, 2018, 2016 and 2014.  Attached to each of the income tax liabilities will also likely be interest and penalties.

If the taxpayer owing payroll taxes is Acme, Inc. and Acme’s owner is John, John faces a trust fund recovery penalty for which he has personal liability with respect to the unpaid trust fund portion of Acme’s payroll tax liability.  John cares deeply that Acme satisfy the trust fund portion so that he does not face a personal assessment of that liability.  He may also care about the employer portion of the payroll tax liability if he wants to keep Acme going, but his main concern derives from fear of personal liability.  If Acme has limited funds with which to pay the taxes or John has limited funds to contribute to Acme to pay the payroll taxes, John wants to ensure that the payments apply to the unpaid trust fund portion for which he has personal liability.  Only after the taxpayer penalties and interest of that portion of Acme’s liability is satisfied can he breathe easy regarding his personal liability.

If Acme or John, on behalf of Acme, makes a payment on the payroll tax liability and says nothing, the IRS will apply the payment to the non-trust fund portion of Acme’s liability first until it satisfies that portion.  By doing so, the IRS preserves the greatest possibility for it to collect additional dollars since it can go after either Acme or John on the trust fund portion but can only go after Acme on the non-trust fund portion.  The failure to make the designation could have significant negative consequences for John.

If Bob is the taxpayer owing income taxes for different years, he too might care about which of the four years to which the IRS applies his payment.  In most situations, the IRS will have assessed the earlier tax periods first, which means the statute of limitations on those periods will run first.  If the taxes for these four years were reported on timely filed tax returns, Bob’s 10-year statute of collection would run from about April 15, 2015 for the 2014 liability to April 15, 2021 for the 2020 liability.  The 2014 has less than four years to run before it expires while the 2020 liability has almost 10 years left.  Additionally, should Bob go into bankruptcy, the 2014 and 2016 liabilities would be classified as general unsecured claims which might be dischargeable with no payments made while the 2018 and 2020 would be excepted from discharge if a bankruptcy petition were filed at this time.  So, Bob has an incentive to designate his payments to the more recent periods, allowing the older periods to disappear more quickly due to the statute of limitations on collection or due to the bankruptcy discharge.  If Bob sends money to the IRS and says nothing, the IRS will almost always apply the money to the oldest period, first to taxes, then to penalties and then to interest.  Once the oldest period is paid, the IRS will almost always move to the next oldest period and again apply the payment to taxes, then penalties and then interest and so on until the liability is paid in full.  By applying the payment to the oldest periods first the IRS generally preserves the longest period of collection on the remaining liabilities and reduces the liabilities susceptible to discharge in bankruptcy.

In CCA 2019110508593544, IRS Chief Counsel gives brief advice on the issue of designation.  It states:

[A] question was raised about whether a taxpayer can designate the payment allocation when the taxpayer makes a quarterly federal tax deposit, attributable to a specific payroll, or whether the payment must be applied in the best interests of the government. Please share the response below with your staff.

A taxpayer is permitted to designate a voluntary payment, but in order for such designation to be proper the request or designation for the application of the payment must be specific, in writing, and made at the time of the payment. A taxpayer has no right of designation of payments resulting from enforced collection measures.

If a taxpayer submits a voluntary partial payment when there are assessments for more than one taxable period, and does not provide specific written instructions as to the application of the partial payment, then the payments will be applied in a manner serving the best interests of the government. The payment will generally be applied to satisfy the liability for successive periods in descending order of priority until the payment is absorbed and is applied to non-trust fund taxes first.

Pursuant to Policy Statement 5-14 (found at IRM 1.2.1.6.3), to the extent partial payments exceed the non-trust fund portion of the tax liability, they are deemed to be applied against the trust fund portion of the tax liability (e.g., withheld income tax, employee’s share of FICA, collected excise taxes). Once the non-trust fund and trust fund taxes are paid, the remaining payments will be considered to be applied to assessed fees and collection costs, assessed penalty and interest, and accrued penalty and interest to the date of payment.

For more information, see the following resources:

Rev. Proc. 2002-26, 2002-1 C.B. 746
Salazar v. Comm’r, 338 Fed. Appx. 75, 79 (2d Cir. 2009) (and cases quoted therein)
IRM 5.7.4.3
IRM 8.25.2.4.4

If you represent a taxpayer in a situation in which paying one tax period or one type of tax provides an advantage over letting the IRS choose the application of payment that most benefits it, you should make a clear designation with your payment.  In addition to describing the designation in the cover letter forwarding the check, you might also consider making note of the designation on the check itself in the notes section.

Taxpayers can only make a designation when they make a voluntary payment.  Involuntary payments such as payments pursuant to a levy, pursuant to a sale, pursuant to a bankruptcy distribution, or other similar situations in which the money comes to the IRS from a source other than the taxpayer do not offer the benefit of the opportunity to designate.  This can provide a good reason for the taxpayer to make a payment rather than to wait for the IRS to take the money through some form of collection action.

Filed Under: Designation of Payment, Employment Taxes

Rescinding the NOD; Prior Opportunities; and Non-Requesting Spouses Behaving Badly – Designated Orders: November 11 – 15, 2019

January 23, 2020 by 2 Comments

Three orders from three judges this week. Of note, I discuss the Service’s authority under section 6212(d) to rescind a Notice of Deficiency (and its futility), along with the Court’s contempt authority under section 7456(c) (and its disuse). Let’s jump right in.

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Docket No. 12248-18 L, Augustine v. C.I.R. (Order Here)

Judge Gustafson grants Respondent’s motion for summary judgment in this CDP case—though only in part, as Respondent conceded noncompliance with section 6751. While the result is fairly straightforward, Petitioner’s history in interfacing with the IRS and TAS—but not the Tax Court—suggests that the importance of seeking Tax Court review wasn’t apparent.

The IRS assessed additional tax liabilities from an audit of 2013 and 2014, which disallowed various Schedule C deductions. The IRS issued a Notice of Deficiency on January 19, 2016; instead of filing a petition, the taxpayer continued corresponding with the IRS. The IRS reaffirmed its decision in a letter dated April 13, 2016—five days before the deadline to file a Tax Court petition.

I’ve seen numerous taxpayers who, desiring not to go to court and believing they can still prevail upon the IRS, continue corresponding with the IRS. In so doing, they often give up their right to go to Tax Court and to obtain meaningful review of the IRS’s underlying decision.  In fact, I’ve seen tax preparers and even CPAs make the same choice. In my view, there is almost never a reason to avoid the Tax Court once the IRS issues a Notice of Deficiency.

Nonetheless, Petitioner did not petition the Tax Court in response to the Notice of Deficiency. Instead, it seems she sought help from TAS, which requested that the IRS “rescind” the Notice of Deficiency.

The IRS does have authority under section 6212(d) to rescind a Notice of Deficiency. If the rescission occurs, the Notice no longer functions as a valid Notice of Deficiency (though does still toll the assessment statute of limitations between the Notice’s issuance and its rescission). Faced with a rescinded Notice, the IRS could not assess additional tax, and the taxpayer could not petition the Tax Court for review.

Unsurprisingly, the IRS does not like to rescind Notices of Deficiency, and so refused TAS’s request to do so here. The criteria for rescinding a Notice of Deficiency are found in IRM 4.8.9.28.1, and include situations where (1) the notice was issued for an incorrect tax amount; (2) the notice was issued to the wrong taxpayer or for the wrong tax period; (3) the notice was issued without considering a properly filed consent to extend the assessment statute of limitation; (4) the taxpayer submits information establishing the actual tax due is less than the amount shown in the notice; or (5) the taxpayer requests a conference with the appropriate Appeals office, but only if Appeals decides that the case is susceptible to agreement. While TAS agreed that the notice should be rescinded—and presumably that one or more of these criteria were met—the IRS apparently did not. Moreover, if TAS’s decision came after the expiration of the 90 day period, the IRM explicitly provides that the IRS should not rescind the Notice. And of course, at that time, the taxpayer has no right to petition the Tax Court.

I’m not sure how long the IRS takes to process requests for rescission, and I’m not sure how long that occurred in this case. But it’s far safer and more productive, in my book, to request review in the Tax Court, ensure oneself of review from IRS Appeals, and resolve the case in this forum.

In this case, TAS did eventually prevail on the IRS to allow Petitioner to have a hearing with IRS Appeals. Still, Appeals made no changes to those in the Notice of Deficiency.

Accordingly, Petitioner was barred from raising the underlying liability under section 6330(c)(2)(B), because Petitioner (1) did receive a notice of deficiency, and (2) had a prior opportunity to dispute the tax before IRS Appeals. While the latter point has been subject to (largely unsuccessful) litigation regarding whether a “prior opportunity” should be limited to a prior judicial opportunity (see our coverage here and here), petitioner clearly loses on the former point.

The remainder of the order is unremarkable. The Settlement Officer offered a payment plan of $490 per month, even though Petitioner never submitted a Form 433-A or filed a delinquent tax return. Unsurprisingly, Judge Gustafson found that Respondent’s decision to sustain the levy notice was not an abuse of discretion. 

Docket No. 20945-17 L, Simon v. C.I.R. (Order Here)

We have another CDP case, this time from Judge Halpern who grants Respondent’s motion for summary judgment to sustain both a levy and a notice of federal tax lien as to trust fund recovery penalties. There are a couple wrinkles that bear mentioning in this case: (1) the definition of a “prior opportunity” under section 6330(c)(2)(B); and (2) designation of payments.

Prior Opportunity

After the TFRP was assessed, Petitioner requested review from IRS Appeals. That appeals “hearing” proceeded as many Appeals hearings do: through exchanges of correspondence and telephone calls. Petitioner never had the opportunity to present his case face-to-face with IRS Appeals. And thus, he argued in the Tax Court that he did not have a true “prior opportunity” under section 6330(c)(2)(B) to dispute the underlying liability, and so wished to do so in the CDP context. (Unlike in the order above, TFRP assessments are not subject to deficiency procedures, so Petitioner accordingly never received a Notice of Deficiency).

Judge Halpern disagreed. In a previous case, Estate of Sblendorio v. Commissioner, T.C. Memo. 2007-94, the Court held on similar facts that “correspondence and telephone conversations between [petitioner] and the Appeals officer are sufficient to constitute a conference with Appeals,” which would constitute a “prior opportunity” to dispute the underlying liability. It’s unclear whether the Tax Court has held similarly in a precedential case; the Court has, however, held that face-to-face hearings are not absolutely required in the CDP context. See Katz v. Commissioner, 115 T.C. 329, 335 (2000). But see Charnas v. Commissioner, T.C. Memo 2015-153 (finding an abuse of discretion based upon the cumulative effect of the SO’s conduct—including failure, upon request, to offer a face-to-face hearing in light of complicated facts).

Of course, the administrative record shows that the petitioner in Simon failed to request a face-to-face hearing during the underlying administrative appeal of the TFRP. The cases cited above uniformly suggest that requesting such a hearing is a pre-requisite to finding an abuse of discretion in the context of a valid CDP hearing. So too, one might suggest, in the context of a prior opportunity. The lesson here: if you believe a face-to-face hearing is important to resolving the underlying liability, request one at the earliest opportunity.

Designation of Payments

The underlying business filed for bankruptcy under chapter 7. During the bankruptcy case, the bankruptcy trustee sent a check for $91,850 to the IRS, which referenced the bankruptcy case number and the company’s name. Neither the check nor the letter accompanying it designated to which tax periods or tax types the payment should be applied.

The IRS applied the payments to the earliest tax period (June 30, 2010), and applied the payments first to the non-trust fund portion of the liability. Petitioner did receive a large credit for the trust fund portion of this liability in the amount of $67,261. Petitioner argued in his Form 12153 and at the CDP hearing that the full amount of the trustee’s payment should have been credited towards the liability, not just the $67,261.

If a taxpayer designates a payment to a particular tax period or particular type of liability (i.e., the trust fund portion of employment taxes vs. the non-trust fund portion), the IRS must honor that designation. Rev. Proc. 2002-26, § 3.01. However, if the payment is not so designated, the IRS will apply the payment “in the best interests of the government.” See id. § 3.02.That usually means applying the payment to (1) the tax period on which the collection statute of limitation will most quickly run, and (2) tax periods and types that have only one potential collection source. Here, the IRS could collect the non-trust fund portion of employment tax liability only from the underlying company; responsible officer of the company never bear personal liability for this type of employment tax debt. In contrast, because the IRS had assessed the TFRP against Petitioner, it could collect the trust fund portion of the company’s employment tax liability both from the company and from petitioner.

So, it makes sense—and indeed, is enshrined in the IRM as policy—that the IRS will apply undesignated payments first to the non-trust fund portion of a liability, absent a designation from the taxpayer. Thus, Judge Halpern finds no abuse of discretion with Respondent’s application of the bankruptcy trustee payment here.

Judge Halpern’s language, however, does raise an interesting question to me. He notes “neither the check nor the letter designates the tax period to which the payment is to be applied, or whether the payment is to be applied towards the trust fund taxes or non-trust fund taxes.”

What if it did? Is there a plausible situation in which a bankruptcy trustee would, in practice, designate a payment on behalf of the debtor? If so, would that designation on behalf of the taxpayer be effective? The language of Rev. Proc. 2002-26 requires that the “taxpayer [provide] specific written directions as to the application of the payment.” § 3.01. I leave it to my colleagues and readers who are better versed in bankruptcy to opine.

Docket No. 17455-16, Hefley v. C.I.R. (Order Here)

Finally, a short jaunt into the difficulties of an innocent spouse defense in a jointly filed petition. The joint petition in this case responded to two IRS notices: a Notice of Deficiency for tax years 2011, 2012, and 2013; and a Notice of Determination regarding an administrative innocent spouse request for the same tax years.

Earlier this year, the non-requesting spouse, Mr. Hefley, filed a Motion for Leave to File Amended Petition to withdraw any dispute regarding the Notice of Determination. Judge Gale notes that he “purported to do so as ‘Counsel for Petitioner’”, and included a signature page apparently bearing the signatures of both spouses. The Court granted this motion shortly thereafter.

In the intervening time, the Court became aware of these facts: specifically, that Mr. Hefley had purported to act on behalf of his spouse as “Counsel”, though lacked authority to do so, given that he was not a member of the Tax Court bar. Further, any such representation would be ethically problematic, given that his interests with regard to the Notice of Determination are diametrically opposed Mrs. Hefley’s interests. Even more problematically, Mrs. Hefley stated in a conference call that she did not sign the Amended Petition, and that it appears to contain a fraudulent signature.

So, Judge Gale decided to void the Amended Petition and deny the motion for leave to file the Amended Petition. Problematically, the case was already set for trial on November 18 and discovery was conducted on the premise that no innocent spouse claim would be raised at trial. The trial would therefore be bifurcated: all issues related to the underlying deficiency would be tried on November 18, and all issues related to the innocent spouse claim would be tried, if at all, at a later date. 

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A final note: while the Court’s actions are certainly warranted, I believe that Mr. Hefley should face more serious consequences. He, in essence, tried to pull the wool over the eyes of the Court, opposing counsel, and his own spouse. The facts indicate he likely produced a fraudulent signature on the Amended Petition. That’s serious misconduct.

The Court’s tools in sanctioning this conduct, however, seem somewhat limited. Section 6673 does not seem to provide a remedy; his actions do not constitute (1) proceedings instituted merely for purposes of delay; (2) a frivolous or groundless position; or (3) an unreasonable failure to pursue administrative remedies. The Court has rules for sanctions in the discovery context, see T.C. Rule 104, but that likewise seems inapposite to the misconduct at hand.

The Tax Court’s contempt powers authorized under section 7456(c) might provide an avenue for sanctioning such misconduct. It provides that “the Tax Court . . . shall have power to punish by fine or imprisonment, at its discretion, such contempt of its authority, and none other, as (1) misbehavior of any person in its presence or so near thereto as to obstruct the administration of justice . . . .” In a prior case, Williams v. Commissioner, 119 T.C. 276 (2002), the Court found the petitioner in criminal contempt of the Court; it imposed no term of imprisonment, but rather assessed a $5,000 fine. The taxpayer there fraudulently informed the Court that he had filed a bankruptcy petition, which would have invoked the automatic stay and thus delayed the case in Tax Court.  (I’d be curious to understand how the Court collects such a fine, as unlike the section 6673 penalty, it is not subject to the Service’s normal assessment and collection procedures).

It appears, however, that the Tax Court doesn’t make much use of its contempt authority (at least, not in published opinions or in its orders). The Court has only cited its authority in 7456(c) in orders five times since June 2011; no order actually found a taxpayer or third party in contempt. Other than Williams, only one recent opinion, Moore v. Commissioner, T.C. Memo. 2007-200, substantively discusses the Court’s contempt power under 7456(c)—though ultimately the Court declines to sanction the petitioner in Moore.

I’d suggest that the Court ought to rediscover its authority under section 7456(c) for situations where, as here, the petitioner has engaged in fraudulent conduct, yet the section 6673 penalty is unavailable.

Filed Under: Collection Due Process, Designated Orders, Designation of Payment, Notice of deficiency

Unpacking the Collection Due Process Case of Melasky v. Commissioner Part 2: The Payment

October 29, 2018 by 1 Comment

As discussed in two prior posts, the Tax Court issued two opinions in the Collection Due Process (CDP) case involving the Melaskys. In 151 T.C. No. 8 it issued a precedential opinion holding that a challenge to the crediting of payment is reviewed pursuant to an abuse of discretion standard and not de novo. In 151 T.C. No. 9 it issued a fully reviewed precedential opinion addressing the collection issues raised in the case before sustaining the determination of the Appeals employee and allowing the IRS to move forward toward levy. See our prior posts on the case here and here.  In this second post on the second opinion, the issue discussed concerns the attempt to make a voluntary payment. The majority decided that the attempt fails leaving the taxpayers with outstanding debt on more recent, but still old, years.

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The Melaskys owe taxes for many years dating back to 1995. Over the years from 1996 until they filed their CDP request in 2011, they made various attempts to settle the debt through offers in compromise (OIC) and installment agreements (IA). They had also made at least one designated payment of a lump sum to one of their more recent tax years.

On Thursday, January 27, 2011, the Melaskys hand-delivered a check for $18,000 to the IRS office in Houston handling their case, directing the IRS to apply the check against their 2009 income tax liability. On Monday, January 31, 2011, the IRS Campus Collection function in Philadelphia issued a levy to the same bank on which the check was drawn. The levy caused the bank to place a 21 day hold on their account and the hold occurred prior to the payment on the January 27th check.

Regular readers of this blog know that a taxpayer can make a voluntary payment and direct the IRS where to apply the check; however, if the IRS collects funds involuntarily the IRS can decide where to apply the levy proceeds and it does so in a manner that best protects the government. We have discussed the general issue of the voluntary payment rule here, here and here.

There are many reasons for a taxpayer to want to make a voluntary payment. In the employment tax context, a corporate taxpayer will almost always want to designate a payment to outstanding trust fund portion of the liability in order to protect corporate officers from the trust fund recover penalty found in IRC 6672. For individual income taxes such as the ones at issue here, taxpayers almost always want to designate payments to the most recent tax years, or the most recently assessed tax years, in order to obtain the possible benefit of older periods falling off the books due to the statute of limitations on collection or due to positioning for a bankruptcy petition in which the priority rules of bankruptcy will allow discharge of older tax years. Whatever was motivating the Melaskys, their strategy followed the normal pattern for taxpayers with multiple periods of outstanding tax liabilities.

The abnormal aspect of this case results from the timing of the levy vis a vis the voluntary payment. While I imagine that this fact pattern may occur in other cases, it would not occur often. The fact pattern also raises the question of whether the IRS sought to levy quickly after receiving a check in order to reorder the application of payments. The court addresses whether the voluntary submission of the check prior to the levy on the bank account permits the Melaskys to designate the application of the payment here or whether the fact that the payment to the IRS actually comes via the levy rather than the check allows the IRS to post the payment to the earliest outstanding liability.

On the same day that the IRS issued the levy to the Melaskys bank, it also sent them a CDP Notice for the years 2002-2003, 2006, 2008 and 2009. They timely requested a CDP hearing and subsequently petitioned the Tax Court upon receiving an adverse determination letter from Appeals. The Tax Court found two issues in the CDP case: (1) did the IRS abuse its discretion in not treating the check as a voluntary payment and (2) did the IRS abuse its discretion in rejecting a proposed installment agreement. Part 3 of this series will focus on the installment agreement aspect of the case while this post focuses on the voluntary payment issue.

The court notes that “a payment by check is a conditional payment because it is subject to the condition subsequent that the check be paid upon presentation to the drawee.” It also notes that delivery of a check does not discharge a debt. Anyone who has ever received a bad check can easily identify with that rule. If, however, a check is honored the payment relates back to the time of delivery of the check.

Here, the bank never honored the check because by the time it went to clear the account had no funds. Since the check did not clear, it could not constitute payment and since it did not constitute payment, any instructions regarding what to do with the payment because irrelevant. The court found that “taxpayers may direct the application of a payment only if payment occurs.” This seems like a rather straightforward application of the law but the petitioners want equity and not law. They argued that the Tax Court should create an equitable exception for situations in which the check does not clear due to that actions of the IRS.

The Melaskys cited no authority for the adoption of such an equitable rule which is not to say they cited no authority. The court finds no reason to create an equitable exception to the normal rule of allowing designation only if a payment occurs. The IRS levy appears procedurally sound in its execution and logical in its use given the long history of non-payment. The court states that “Respondent did not cause petitioners’ check to bounce; petitioners’ check bounced because they owed and have chronically failed to pay various taxes, a portion of which was collected by levy after respondent’s man attempts at compromise failed to reach a voluntary resolution.”

On this point Judge Homes raises a vigorous dissent; however, he makes clear in footnote 6 that his dissent is not grounded in equity.  One could almost get the feeling equity is a bad word here. As an aside, you may be wondering how Judge Holmes can even participate in a fully reviewed opinion since his term as an appointed Tax Court judge ended on June 29, 2018, causing him to assume senior status while Congress works through its amazingly quick appointment process to approve his reappointment. Because he is the trial judge in this case, he is allowed to participate in court conference on this case and to have his voice heard in the fully reviewed opinion.

Judge Holmes has concerns that the majority’s failure to create an equitable rule in this situation stems from the incredibly bad tax payment behavior exhibited by the Melaskys across the decades leading up to this opinion. On the point of his dissent, Judge Lauber writes a spirited concurring opinion in which he is joined by several judges. Judges Buch and Pugh write a narrow concurring opinion pointing out that on the facts of this case it appears the IRS followed all procedures but on similar facts it might be possible to find that the levy interfered with the attempted voluntary payment. All in all, the opinion gets very long because of the depth of the disagreement and the Tax Court shows more fractures in its personal relationships than we might normally observe. For this inside glimpse, you might read the entire opinion.

In footnotes, Judge Holmes raises interesting points about the IRS hitting the Melaskys with a bad check penalty. He expresses concerns about whether in doing so it followed the requirement of IRC 6751(b) to obtain proper approval and why it would impose such a penalty when IRC 6657 has a good faith and reasonable cause exception. It’s hard to imagine how this penalty would apply on these facts when they tendered payment with sufficient funds in the account and had no reason to know of the impending levy. Because the amount is small relative to the overall liabilities and maybe because of the timing of the imposition of the penalty vis a vis the CDP case, the Melaskys did not raise an objection to the imposition of this penalty. So, that issue will wait for another day.

Judge Holmes finds that the Appeals employee handling the CDP case did not provide an adequate explanation of the basis for concluding the payment did not meet the voluntary payment rules and, therefore, the court should remand the case. The primary concern raised by Judge Homes brings in the Chenery doctrine which binds the agency to the reasons expressed for its decision. He provides a detailed analysis of federal tax cases regarding the timing of application of payment when made by check. The concurring opinion does not spend much time addressing this collection of cases but focuses on Judge Holmes analysis of contract law and the interference the levy created with the ability of the Melaskys to complete performance of the payment of their check.

While Judge Holmes acknowledges that the parties had no express contract he points to the Melaskys’ reliance on Rev. Proc. 2002-26. He proposes a bright line rule that if the IRS causes a check to bounce the taxpayers should receive the benefit of the voluntary payment rule. The concurring opinion pushes back hard on the use of contract principles, the application of the Chenery doctrine in the way described by Judge Holmes and in the idea that the Appeals employee did anything wrong in making his decision. As always I learned a lot by reading Judge Holmes dissent but I am persuaded here that the majority got it right. Whether the IRS inadvertently caused the attempted voluntary payment to fail or the cause had been some third party, the failure of the check to clear keeps a taxpayer from gaining the benefits of the voluntary payment rule. As the concurrence points out, the Melaskys could have obtained a cashier’s check had they wanted to make sure the funds were in the account when the IRS sought to cash the check. That may be the greatest lesson for those seeking to make a voluntary payment and who want to avoid unpleasant surprises.

 

Filed Under: Collection Due Process, Designation of Payment

Where Does Designation of Payment Fall in the List of Items Appeals Must Verify in a Collection Due Process Case

October 14, 2015 by 4 Comments

The recent case of Au v. Commissioner sort of raises the issue of verification in a Collection Due Process (CDP) case.  I say sort of because I read the case to raise that issue but it does not appear that the parties or the Court viewed the case as raising this issue.  Because of the way the pro se taxpayer presented the case, the Court did not focus on the issue of verification but rather on the taxpayer’s failure to follow through by providing information the IRS requested.

Section 6330(c)(1) requires that Appeals verify that all “requirements of any applicable law or administrative procedure have been met.”  Mr. Au was unrepresented in the Tax Court case and probably in the CDP hearing as well.  The IRS had assessed a trust fund recovery penalty (TFRP) for unpaid employment taxes at a business where he was a principal.  The opinion says that he attached to the Form 12153 requesting the CDP hearing a statement “I request that the equivalent hearing be held in the jurisdiction of Honolulu, Hawaii.”  On the form itself he requested “(1) a CDP hearing or an equivalent hearing; (2) an offer-in-compromise (OIC); and (3) a lien discharge.”  My guess is that Mr. Au did not have a clear picture of what he was requesting.  It appears that he said nothing about application of payments on the TFRP when he submitted the Form 12153.  Despite the conflicting language in his request concerning whether he sought a CDP hearing or an equivalent hearing, the IRS and the Court treated his timely filed request as one seeking a CDP hearing.  The IRS issued a determination letter upholding the proposed levy action, he timely petitioned the Tax Court and it sustained the IRS determination.  In doing so, the Court does not address whether Appeals had a duty to verify the proper application of payments.  This post will explore that duty.

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Part of the opinion deals with the issue of whether he could get a face to face hearing in Hawaii and the opinion finds in essence that he waived his chance for such a hearing by not responding to Appeals offer for such a hearing in a timely fashion.  I will not spend more time on that issue but the case suggests by implication that giving a taxpayer 15 days to make the request for a face to face hearing is sufficient.  That request came early in the case and the time to respond passed before he made his desire clear.  It does not appear that the request to have the hearing in Honolulu contained in his request for a CDP hearing provided any benefit to him in seeking to have the face to face conference.

In his initial correspondence with the Settlement Officer after the submission of the Form 12153, Mr. Au asserted “that he had made voluntary payments of over $300,000 that the IRS should have applied against his TFRPs.”  Appeals issued a determination letter upholding the IRS decision to levy to collect the taxes.  Mr. Au renewed his argument about designation at the CDP hearing before the Tax Court.  The Court found the following:

Generally, a taxpayer must raise an issue at a CDP hearing to preserve it for this Court’s consideration.  Gianelli v. Commissioner, 129 T.C. 107, 115 (2007); sec. 301.6330-1(f)(2), Q&A-F3, Proced. & Admin. Regs.  The merits are not properly raised if the taxpayer mentions an issue but fails to present Appeals with any evidence regarding that issue after being given a reasonable opportunity to do so.  See Delgado v. Commissioner, T.C. Memo. 2011-240; sec. 301.6330-1(f)(2), Q&A-F3, Proced. & Admin. Regs.

There is nothing in the record to show that petitioner provided any evidence to Settlement Officer Cochran in regard to this issue.  Settlement Officer Cochran gave petitioner sufficient time to submit evidence of his alleged designation, but he failed to do so.  Instead, petitioner simply made unsupported statements that he had properly designated the application of voluntary payments against his TFRPs.  Accordingly, we find that petitioner did not properly raise this issue during the CDP hearing, and therefore he cannot dispute this issue before this Court. (emphasis added)

I wrote recently about the concept of variance in CDP cases.  The concept clearly relates to affirmative issues a taxpayer seeks to raise such as collection alternatives to levy, e.g., OIC or Installment agreement, whether the taxpayer can contest the underlying merit of the liability or raise innocent spouse status.  Section 6330(c)(1) is not clear, however, about what must be verified.  Is the proper application of a payment something that the IRS must verify as part of its administrative practice or is it an affirmative matter the taxpayer must properly raise or is it something in the middle?

In Lee v. Commissioner, a full T.C. opinion decided earlier this year, Judge Wells confronted the issue of verification in a TFRP case. Les wrote about this case. The Lee case does not specifically address the designation issue and whether it is a matter subject to verification but it does give some additional definition concerning verification in the TFRP context. The discussion of verification in Lee supports the view that Appeals has an affirmative responsibility to verify in these cases even if it left open all of the possible issues included in the verification process.

Designation of payment comes up frequently in TFRP cases because the responsible person making payments to the IRS on their own behalf or through the entity wants to have the payments applied to the portion of the liability for which the responsible person bears personal responsibility in order to eliminate or reduce their personal exposure. Most TFRP cases involve unpaid employment taxes and that appears true in Mr. Au’s case. When a corporation fails to pay its employment taxes, the unpaid taxes include both withheld income and social security taxes owed by the individual employees of the business as well as the employer portion of the employment taxes (basically half of the social security and Medicare taxes.) The TFRP imposes a personal liability on responsible persons of the corporation only for the withheld taxes that the corporation holds for the IRS in trust and not for the employer portion of the employment taxes. Frequently, responsible persons, or potentially responsible persons, will individually pay or cause the corporation to pay a portion of the outstanding employment tax liability and will designate that the IRS apply the payment to the trust fund portion of the outstanding liability in order to reduce or eliminate the TFRP. The IRS position of designation resides in Revenue Procedure 2002- 26 where IRS states that it will apply a voluntary designation from taxpayer in the manner requested by the taxpayer. Issues concerning designation usually turn on whether the payment was voluntary or the designation was clear. The Revenue Procedure and the process for designation suggests that the issue of designation makes the case more clearly a verification issue than a merits issue.

Judge Vasquez treats designation of payment as a merits issue and applies the regulation to deny the taxpayer the opportunity to raise the issue before the Court since he raised but did not pursue the issue before Appeals.  I find the issue a close one.  I would not necessarily advocate that Appeals should have to verify in each case whether the taxpayer designated the application of his payments and whether the IRS properly followed the designation request; however, if the taxpayer raises that the IRS has improperly followed an administrative practice, it seems that the IRS should have the duty to at least take a look and go as far as it can on this issue.  Without help from the taxpayer in the form of a copy of the correspondence or other indicia of designation, the IRS may not be able to determine if its administrative procedures were properly followed but it could take a look.  The statute may require it to do so.

This was not a small matter or a case where designation had no impact.  If the responsible officer has paid $300,000 on a trust fund or employment tax debt, it should be possible for the Appeals employee to go into the system of the IRS and take a look at those payments.  With that amount of money at issue, it is also possible that a revenue officer was involved in the collection of the tax.  Should the Appeals employee affirmatively charged with verifying the correctness of the IRS in following its administrative procedures have a duty in a CDP case to look to see if the IRS properly applied the payments where the taxpayer alleges it did not do so?

I think the Appeals employee did have some responsibility to verify that the IRS properly followed administrative procedures regarding the application of payments as a part of the verification process.  Therefore, is seems that the Court should have looked at that verification rather than simply denying the taxpayer any review of this issue because he did not provide sufficient information to the Appeals employee.  The Court may well have ended up back at the same result because the Appeals employee could not find any designation by the taxpayer in the IRS records and therefore verified that the IRS followed procedures based on the information available; however, that would seem a better result under the statute than treating this as a merits issue on which the taxpayer bears complete responsibility.  Because the issue of designation may require something more than just looking at IRS records, it straddles a line between the duty of the IRS and the duty of the taxpayer leaving an unclear picture of the responsibility of each.

The Au case appears to present an issue of first impression, but the Court delivers it in a non-precedential memo opinion.  Because the taxpayer was pro se, both Appeals and the Court were at a disadvantage in dealing with the issue.  Congress did not clearly define the scope of section 6330(c)(1).  This opinion does nothing to clear the waters.  Since the opinion does not bind the judges on the Court by setting precedent, others arguing that IRS has not properly posted designated payments should raise the argument that the Appeals employee has a duty to verify the proper posting of payments pursuant to section 6330(c)(1).  Providing information and assistance to Appeals in verifying the proper application would help in reaching the correct result.

Filed Under: Collection Due Process, Designation of Payment