IRC 7459(d) and the Impact of Dismissal

June 4, 2021 by 2 Comments

On May 20, 2021, the Court of Federal Claims decided the case of Jolly v. United States, Dk. No. 20-412.  Ms. Jolly pursued the case pro se.  The court lists the opinion as not for publication. The case involves a refund suit covering four tax years.  The court decided not to dismiss her complaint rejecting the government’s motion.  Carl Smith noticed this decision and in his email forwarding the opinion he provided much of the substance of this post. 

In amicus briefs filed by the tax clinic at Harvard in the cases of Organic Cannabis and Northern California, the clinic argued that the court should not be concerned about turning late filing of a deficiency petition into a merits issue, rather than a jurisdictional one.  The counter-argument (which the 9th Cir. accepted in Organic Cannabis) was that, if a deficiency petition is dismissed for late filing and that is a merits dismissal, then it upholds the deficiency under 7459(d), and so the Tax Court decision could present a res judicata bar to a person seeking to litigate the deficiency later by paying and suing for a refund.  In our cert. amicus brief in Northern California, we acknowledged that that was a theoretical possibility.  We noted in our brief that neither Carl Smith nor I could recall any case where a person who was dismissed from the Tax Court for late filing later full-paid the deficiency and sued for refund.  We acknowledged that it is possible such rare cases existed, but said they must be a very few since it could arise in the traditional refund context or when there is no balance due but a disallowed refundable credit and a late filed petition. 

Because of the possibility, Nina Olson, when she was the National Taxpayer Advocate made a legislative proposal to fix the jurisdiction issue, and it contains a modification to 7459(d) that would except untimely filed petition dismissals from the rule upholding the deficiency. 

The Jolly case presents the fact pattern we said we did not recall ever seeing. 

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In Jolly, for the 2016 year, the IRS issued a notice of deficiency.  Jolly, pro se, late-filed a Tax Court petition, which was dismissed for lack of jurisdiction.  The IRS applied overpayments from 2018 and 2019 that were shown on the returns to the 2017 deficiency, still leaving a partial balance due for 2017.  The IRS did not apply any of the overpayments to 2016.  This is unusual because normal procedure at the IRS applies payments to the earliest period to tax, then penalty and then interest.  It is unclear why the payments were posted in this manner in the Jolly case. 

Jolly, again pro se, then filed suit in the Court of Federal Claims seeking a refund for each of the years 2016 through 2019.  The DOJ moved to dismiss all four years, though on different grounds.  It wanted the court to dismiss 2016 and 2017 for failure to full pay and wait 6 months after a refund claim to bring suit – i.e., lack of jurisdiction.  It wanted the court to dismiss 2018 and 2019 because the overpayments from those years had been applied to 2017 – i.e., failure to state a claim since she received the refund she requested on her returns for those years.  Pro se taxpayers commonly misunderstand what it means when the IRS offsets a liability.  Clinic clients regular arrive at the door complaining of one year when the IRS has granted the requested refund for the year identified by the taxpayer but taken the refund to an earlier year where the problem exists.  In somewhat confusing rulings, the court denied  the government’s motions for all years.

For 2016 and 2017, the court thinks it is important to decide whether notices of deficiency were issued for each year.  It’s not clear why it feels this way.  The court finds that a notice of deficiency was issued for 2016, but not 2017.  The court notes the IRS has lost the 2017 administrative file, and the court won’t accept at this time only circumstantial evidence of mailing.  The court says that the credits from 2018 and 2019 might have full-paid the 2016 liability and part-paid the 2017 alleged liability based on the evidence in the record at this time.  This approach seems confused.  It is implicit in the court’s ruling that if a notice of deficiency was not sent for 2017, the Flora rule doesn’t apply to the erroneous assessment of the deficiency and the credits from 2018 and 2019 can be moved from the 2017 year to the 2016 year to meet Flora.  I would have thought Flora requires full payment of an assessment, even if the assessment was not made correctly procedurally, though I have never researched case law on that issue, if any. 

In addition to this argument, what about the government argument that the taxpayer had to file a refund claim and wait six months?  Clearly, a 2019 overpayment used to finish paying the 2016 year could only have been applied as a credit in 2020, and suit here was brought in 2020.  It is very unlikely that the taxpayer filed a refund claim for 2017 between the time that the 2019 credit was posted to 2017 and then waited six months to bring suit.  In denying the motion, the court doesn’t discuss this issue.  Here’s the last paragraph of the opinion as relates to the motion for 2016 and 2017:

If Ms. Jolly’s 2017 deficiency of $6,371.76 does not exist, the math follows: applying Ms. Jolly’s 2018 and 2019 tax refund ($1,947.00 and $1,255.00, respectively) to only her 2016 assessment of $2184.81 results in a residual amount of around $1017.19.2 As there is a factual dispute underlying the jurisdictional allegation in the government’s Rule 12(b)(1) motion, the Court “weigh[s] evidence” and “find[s] facts” while “constru[ing] all factual disputes in favor of [Ms. Jolly].” Knight, 65 Fed. Appx. at 289; see also Cedars-Sinai Medical Center, 11 F.3d at 1583–84, James, 887 F.3d at 1373. Accordingly, based on the record before the Court, specifically the government’s failure to locate Ms. Jolly’s 2017 IRS administrative file, the Court finds Ms. Jolly may have paid her full tax liability before filing this lawsuit, and thus the Court has subject matter jurisdiction over her 2016 and 2017 tax refund claims. See Flora, 362 U.S. at 150.

It is also unclear why the court did not dismiss the 2018 and 2019 years for failure to state a claim.  The government argued that the claims (shown on original returns) had been paid by application of the overpayments to 2017.  A taxpayer should not be able to bring a refund suit for the year in which overpayments occurred that were used as credits against earlier-year balances due.  Such a suit could only be brought for the earlier years to which the credits had been applied.  The court seems to think that because it determines that the 2017 assessment was improper, the IRS must be deemed not to have made the credits of the refund claims shown on the 2018 and 2019 returns.  But, even if so, why didn’t the court say that the 2018 overpayment should be deemed to partly pay the 2016 deficiency, so at least there can be no overpayment suit relating to 2018?  Here’s the entire discussion of why the court denies the DOJ 21(b)(6) motion for 2018 and 2019:

The government further contends Ms. Jolly is not entitled to any recovery for 2018 and 2019 since Ms. Jolly received her 2018 and 2019 refunds as payments towards her 2017 balance. Gov’t MTD at 9–10. As discussed supra, the absence of a notice of deficiency bars the IRS from assessing a tax deficiency against Ms. Jolly in 2017, thus, the record before the Court compels a finding that the IRS possibly owes Ms. Jolly a residual amount after applying her 2018 and 2019 tax credit towards her 2016 balance. Accordingly, “accept[ing] well-pleaded factual allegations as true and . . . draw[ing] all reasonable inferences in favor of [Ms. Jolly],” the Court finds Ms. Jolly alleges “enough facts to state a claim to relief [regarding her tax refund of 2018 and 2019] that is plausible on its face.” Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007); see also Athey v. U.S., 908 F.3d 696, 705 (Fed. Cir. 2018) (quoting Call Henry, Inc. v. U.S., 855 F.3d 1348, 1354 (Fed. Cir. 2017)) (When deciding a Rule 12(b)(6) motion to dismiss, the Court “must accept well-pleaded factual allegations as true and must draw all reasonable inferences in favor of the claimant.”).

Jolly will struggle to win this case, but perhaps the court’s ruling will allow her to prove to the Tax Division attorney handling the case that she should not have been assessed in 2016 and that she is entitled to a refund, even if she is not entitled to bring a refund suit for four years.  Since much confusion seems to surround the 2017 year and how the assessment came to exist for that year and why the IRS offset the later refunds to 2017 instead of 2016 perhaps this pause will allow time for clearing up that issue as well. The judge seems to misunderstand the basis for refund litigation but that will no doubt be worked out over time.  The case is most notable because it represents an example of someone who missed their chance to go to Tax Court but followed through in seeking a return of the tax through the filing of a refund suit.  Although Carl and I said we did not know of a case with those facts, perhaps we should have remembered the case of Flora which had those very facts and raised the question of what happens when you miss your chance to go to Tax Court.  In the Flora case we know that the Supreme Court held, in the fact of an unclear statute and contradictory prior case law, that the taxpayer can only bring the refund suit by first fully paying the tax, making a timely refund claim, waiting for the claim disallowance letter (or the passage of six months) and then coming to court.  If you want to read more about Flora and the parallels with the Jolly case, here is an article I wrote about Flora.

Filed Under: Flora, Notice of deficiency

Are FBAR Penalties Taxes for Purposes of the Flora Rule?

April 19, 2021 by Leave a Comment

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 to 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 possibility that the Flora rule could apply to non-tax issues first arose sua sponte in a Third Circuit case in 2018 which I wrote about here (see also my article on Flora from last year).  That post also contains a link to an excellent post by Jack Towsend.

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I think the attorneys for Mendu may have read the prior blog post but if not they definitely read the Bedrosian opinion discussed in the blog post.  In Mendu, in a flip of the normal situation, the taxpayer argues that Flora applies and their case should be dismissed while DOJ argues on behalf of the IRS that Flora does not apply since this case does not involve a liability under the IRC.

The court picks up on why the plaintiff in this case would want the case dismissed and would make the Flora argument raised sua sponte in the Bedrosian case:

On November 8, 2019, the Federal Circuit issued its decision in Norman v. United States, 942 F.3d 1111 (Fed. Cir. 2019); as a result, the stay expired. In Norman, the Federal Circuit held that a now out-of-date Treasury Regulation did not cap FBAR penalties for willful violations at $100,000. The Federal Circuit’s ruling in Norman, which binds this Court, may have given Mr. Mendu pause about continuing litigation in this circuit because on January 20, 2020 — facing a counterclaim against him for potentially 700 times greater than the amount sought in his complaint — Mr. Mendu sought to dismiss his own complaint for lack of subject-matter jurisdiction, along with Defendant’s counterclaim. See generally Pl. Rule 7(b)(1) Mot. In his Rule 7(b)(1) Motion, filed in 2020, Plaintiff based his sudden change in course on a footnote in in a case decided two years earlier, Bedrosian v. United States, 912 F.3d 144, 149 n.1 (3d Cir. 2018). In that footnote, which appears to be dictum, the United States Court of Appeals for the Third Circuit (Third Circuit) commented, without substantive analysis, that it was “inclined to believe” that FBAR penalties are internal-revenue laws within the scope of 28 U.S.C. § 1346(a)(1), and are therefore subject to the full payment rule as articulated in Flora v. United States, 362 U.S. 145, 164 (1960). Pl. Rule 7(b)(1) Mot. at 4-5, 7-11. Accordingly, Plaintiff now believes that the Flora full payment rule requires this Court to dismiss Plaintiff’s claim for illegal exaction of his $1,000 partial payment because Plaintiff has not fully paid the FBAR penalty at issue. Pl. Rule 7(b)(1) Mot. at 3-4. Mr. Mendu notes that, because this Court does not have independent jurisdiction over the Defendant’s counterclaim for $752,920, this Court must dismiss the Defendant’s counterclaim as well. Pl. Rule 7(b)(1) Mot. at 2, 11-14; Pl. Resp. to Cross-Mot. at 12-15.

Because of the potential huge exposure in the Court of Federal Claims and the much smaller exposure that might exist in the Central District of California, one can hardly blame petitioner for trying to remove their case from this jurisdiction where the law has turned unfavorable and try to get to another location where the law might be much better.  Unfortunately for petitioner but fortunately for almost everyone else, petitioner’s Flora argument does not gain any traction.

The court sets the scene for its discussion of the application of Flora by stating:

The parties agree that the Flora full payment rule only applies if it is an “internal-revenue tax” as that term is used in section 1346(a)(1). See Pl. Rule 7(b)(1) Mot. at 7; Def. Resp. at 4. As noted, if FBAR penalties are considered internal-revenue taxes, then the Flora full payment rule applies, and this Court lacks jurisdiction over Plaintiff’s tax refund claim because the Plaintiff has not paid the assessed $752,920 FBAR penalties in full. Conversely, if FBAR penalties are not internal-revenue taxes then Flora full payment rule does not apply, and this Court has jurisdiction over Plaintiff’s $1,000 illegal exaction claim. See Ibrahim v. United States, 112 Fed. Cl. 333, 336 (2013) (finding that while tax refund claims are subject to the Flora full payment rule, the full payment rule does not apply to other illegal exaction claims).

The court then finds that the FBAR penalty is not a tax.  The fact that title 31 and not title 26 imposes the FBAR penalty is something the court describes as more than a mere technicality.  The court finds not only that the FBAR penalty derives from a separate statutory scheme, but that the reasoning behind the Flora decision does not apply in this context, since full payment of the penalty does not matter for this penalty the same way it matters for taxes and other penalties.  The court finds the footnote in the Third Circuit’s opinion suggesting, but not holding, that perhaps Flora should apply to the FBAR penalty does not provide a persuasive basis for bringing Flora into an entirely different statutory scheme.  After analyzing several different reasons why the footnote falls short of persuading, it concludes this section of the opinion by stating:

It may be accurate that every internal-revenue law is not necessarily contained in Title 26. However, Congress’s specific placement of the FBAR in Title 31, the stated purpose of the BSA, and the fact that Congress chose not to employ traditional tax collection procedures to recover FBAR penalties collectively demonstrate that Congress did not intend to subject FBAR penalty suits to the Flora full payment rule.

The case then turns on the rules of the Court of Federal Claims.  The court rules do not track the Tax Court rules that do not allow a petitioner out of a deficiency case once properly filed (see discussion here); however, the rules do provide that once the defendant files an answer asserting a counterclaim the petitioner cannot seek dismissal of the counterclaim would not stand on its own in the court.  Here, the huge counterclaim made by the government would not survive if the complaint were withdrawn.  So, Mr. Mendu remains stuck in the Court of Federal Claims instead of being allowed to beat a retreat to the possible friendlier confines of the Central District of California.  Perhaps, he will continue to make the Flora argument.  I hope the court will continue to knock it down.

I do note that occasional guest blogger, Lavar Taylor, just won a big FBAR case in the 9th Circuit.  So, maybe Mr. Mendu has a good reason for wanting a change of scenery to Southern California. In Boyd v. United States,___ (9th Cir. 2021) the court held that 

Examining the statutory and regulatory scheme for reporting a relationship with a foreign financial agency under § 5314, the panel held that § 5321(a)(5)(A) authorizes the IRS to impose only one non-willful penalty when an untimely, but accurate, FBAR is filed, no matter the number of accounts.  

Perhaps we will give a further discussion of Lavar’s case in a future post.

Filed Under: FBAR, Flora

Using Bivens to Attack Flora

July 17, 2020 by 2 Comments

In Canada v. United States, 125 AFTR2d 2020-960 (5th Cir. 2020) the taxpayer brought a Bivens suit seeking damages against the revenue agents because the agents caused the IRS to assess against him a tax shelter penalty under IRC 6707 in an amount so high payment of the penalty was a practical impossibility. If this story sounds similar, remember the case of Larson v. United States, 2018 U.S. App. LEXIS 10418   (2nd Cir. 2018) discussed here and here.  Larson is not the only other case to reveal this problem.   Other cases with this same problem include Diversified Group Inc. v. United States, 841 F.3d 975 (Fed. Cir. 2016), which tried unsuccessfully to argue that the penalty was divisible, and the three circuit cases litigated by Lavar Taylor seeking unsuccessfully to get a foot in the door using the merit litigation provisions of Collection Due Process discussed here.  The ability of the IRS to assess a non-divisible penalty under IRC 6707 in a staggering amount puts taxpayers back in the boat they were in prior to the creation of the Tax Court. It also reminds us that 100 years ago Senators pushed for the creation of the Tax Court in order to prevent individuals from seeking bankruptcy as a refuge from taxes they could not contest judicially without full payment.

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In Canada, bankruptcy is exactly where he went so that he could litigate the merits of his tax liability under B.C. 505(a) since he did not have enough money to meet the Flora rule.  The taxpayer won the merits of his case in bankruptcy beating back the incredibly high penalty amount assessed by the IRS. United States v. Canada (In re Canada), 574 B.R. 620, 623 [119 AFTR 2d 2017-1752] (N.D. Tex. 2017).  After succeeding in essentially eliminating the liability through the bankruptcy proceeding, he turned and argued that the agents who caused the assessment of this penalty knew that he had no prepayment forum where he could litigate the liability and knew they were wrongfully forcing him into bankruptcy.  He brought this Bivens suit seeking to recover damages and attorney’s fees from the individuals he blamed for being forced into bankruptcy.  The Fifth Circuit, affirming the lower courts’ dismissal of the case, carefully analyzed the factors necessary for a Bivens action, before pointing out that precedent in recent decades disfavors expansion of the original decision and two cases decided shortly thereafter.  The court also points out that if successful, his suit would provide an end run around the Flora rule of full payment.

Because I think the Flora rule should not apply to non-deficiency cases, I am not too saddened by an end run around Flora.  I also applaud the ingenuity of the argument here; however, the Supreme Court has made it clear in the decades following Bivens that it does not want to expand the grounds for obtaining recovery from government agents.  The result here comes as no particular surprise.  I found heartening the success of Mr. Canada in removing the penalty at the bankruptcy level.

For anyone not familiar with Bivens cases and the IRS we have discussed them previously here and here.  Government agents at all agencies need protection from personal suits brought concerning actions taken in the scope of their employment.  Interpreting that scope broadly makes sense as we don’t want to chill the government employees from doing their job.  At the same time if government employees do something so egregious and outside the scope of their employment, it also makes sense that at some point the immunity that protects them from personal liability goes away.  Bivens brings out facts where the immunity goes away, but the Supreme Court wants and needs to carefully control the circumstances where that exists.  The Fifth Circuit in Canada looks at the history of the case law after Bivens in concluding that the actions of the revenue agents in assessing the 6707 penalty against Mr. Canada did not rise to the level of action that could give rise to a personal liability against them.

Canada argues that the district court below improperly considered the special factors by applying a “sound reason” standard rather than a “convincing reason” one. Canada asserts the latter is what Ziglar requires.

The Fifth Circuit finds that Canada cannot fit himself into one of the narrow paths for application of Bivens.  It points out that if what he seeks is some form of compensation for his efforts to rid himself of the 6707 assessment, he had other paths available:

It is unclear why Canada did not simply file an application for fees in the bankruptcy court or in the initial district court. Canada states the IRS’s appeal to the district court deprived the bankruptcy court of jurisdiction to consider his fee request. Canada also contends that the appeal forecloses the IRS’s untimeliness argument or is a compelling reason to extend the 26 U.S.C. § 7430‘s 30-day period. These arguments make little sense. He could have filed a motion for the recovery of fees at any time during the pendency of the case in the bankruptcy court. Canada also had the option of moving to reopen the bankruptcy case once the initial district court’s ruling on appeal became unappealable. See 11 U.S.C. § 350(b) (“A case may be reopened in the court in which such case was closed to administer assets, to accord relief to the debtor, or for other cause.”). Similarly, Canada had the ability to ask the initial district court to award him fees anytime between the start of the appeal and 30-days after the IRS could no longer appeal the district court’s order. There is no convincing reason why Canada could not have filed an application for fees under 26 U.S.C. § 7430 in one of those two courts before August 2017 because of an appeal that ended on May 8, 2017. Nevertheless, assuming arguendo that his proposition is accurate, he still could have filed this lawsuit before the 30-day time period lapsed.

While I am sympathetic with Mr. Canada because the current interpretation of the Flora rule essentially forced him into bankruptcy, the Fifth Circuit’s opinion makes sense to me.  Bivens does not seem like the right place to go for the wrong he has suffered.  Bringing an application for fees seems more appropriate even though I understand this might not adequately compensate him for the trouble he has endured.  The real answer lies in removing the Flora rules as a barrier to litigating the correctness of certain penalty assessments.  Until that problem goes away, others will use their creative energies similar to the way Mr. Canada has done.  The problem is not the agents.  The problem lies with the current interpretation of Flora which prevents, as a practical matter, taxpayers from contesting certain assessable penalties.  It also lies with Congress which has created the assessable penalties leaving taxpayers no alternative but bankruptcy should they seek to contest the liability.  Congress knew better than this a century ago when it created the predecessor to the Tax Court.

Filed Under: Bankruptcy, Bivens, Flora

Cracks in the Flora Rule? Definition of a “Tax” and the New World of Refundable Credits

November 13, 2019 by 5 Comments

This year, the Notre Dame Tax Clinic litigated a case in the U.S. District Court for the Northern District of Indiana, which sought a refund of taxes claimed on our clients’ amended tax return. Alexander Ingoglia, a 3L at the Notre Dame Law School and a student in the Clinic, worked on this case last spring, and composed our response to the government’s motion to dismiss for lack of jurisdiction. Alex describes the case and the cracks it might show in the Flora rule.  – Patrick  

In 1960, the United States Supreme Court decided United States v. Flora and established the full-payment rule.  The rule requires plaintiffs to pay their entire tax deficiency before obtaining jurisdiction to sue the government for a tax refund in federal district court or the Court of Federal Claims.  However, we encountered a case in the Notre Dame Tax Clinic this year that presented facts that challenged the Flora rule.  While the case came to an end before the court considered its jurisdiction with respect to the facts, several unique facts established a credible distinction from Flora’s full-payment rule.  As a student attorney in the clinic, I had the opportunity to research Flora’s progeny and the statutory meaning behind the underlying jurisdictional hurdle while representing our client.

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Factual and Legal Background

Our clients, Mr. and Mrs. Burns, originally filed a timely 2014 tax return, which properly claimed their two grandchildren as dependents.  The Burns’ tax return preparer, however, failed to claim the Burns’ deserved Child Tax Credit (“CTC”) and Earned Income Tax Credit (“EITC”) with respect to the grandchildren.  Pursuant to the Burns’ 2014 tax return, the couple received a $617 tax refund.

When the Burns switched tax preparers, their new preparer realized the mistake and filed an amended return on their behalf in April 2016.  At the time the Burns filed their amended return, they owed no taxes to the IRS.  The Burns reported a $1,889 decrease in adjusted gross income and claimed the EITC and CTC in the amounts of $5,430 and $1,588, respectively.  The Burns’ new tax preparer also noticed a $70 understatement in the Burns’ self-employment tax and reported the increase on the amended return.  In total, the Burns sought to receive a $6,948 refund after combining the additional credits with the increased self-employment tax assessment.

The IRS received the return, but rather than sending the Burns their nearly $7,000 refund, the IRS only assessed the additional $70 self-employment tax.  The IRS sent nothing denying the credits or even a request for additional information to substantiate the claimed credits. The Burns never received a right to challenge the denial of credits administratively or otherwise.

The Notre Dame Tax Clinic filed a complaint in district court on the Burns’ behalf.  The complaint stated that the Burns timely claimed a refund in their 2014 tax return, but that they never received any indication that their claims were insufficient or denied.  Instead, the claimed credits were selectively ignored while the IRS recognized the increased self-employment tax in the same 1040X.  The complaint sought relief in the form of the Burns’ $6,948 refund.

In response, the Department of Justice (“DOJ”) filed a Motion to Dismiss for lack of jurisdiction.  The DOJ asserted that the district court lacked jurisdiction to hear the case, pursuant to 28 U.S.C. § 1346(a)(1), which states that the district courts have original jurisdiction over civil actions “for the recovery of any internal-revenue tax alleged to have been erroneously or illegally assessed or collected . . . .”  This section serves as a limited waiver of sovereign immunity, allowing plaintiffs to sue the government in federal court. 

Although the section allows plaintiffs to sue the government to obtain their allegedly deserved refunds, the Supreme Court interpreted the limited waiver to include a “pay first and litigate later” requirement.  Flora v. United States, 362 U.S. 145 (1960).  Without a plaintiff fulfilling the “pay first and litigate later” requirement, the district court lacks jurisdiction to hear the case.  The Seventh Circuit reiterated the full payment rule, holding that “[f]ull payment is a jurisdictional prerequisite imposed by Congress.”  Univ. of Chicago v. United States, 547 F.3d 773, 785 (7th Cir. 2008) (citing Flora, 362 U.S. 64–65, 75, 78).  This interpretation of 28 U.S.C. § 1346(a)(1) prevents taxpayers from paying only a small portion of their tax bill to obtain district court jurisdiction. 

Of course, § 1346(a)(1) only dictates jurisdiction in the District Courts and the Court of Federal Claims.  Taxpayers retain the ability to bring cases in tax court without full payment (or any payment) of an alleged tax liability.  However, to sue for a refund in district court, Supreme Court and lower courts’ precedent has long held that a plaintiff must fully pay their tax bill before utilizing the limited waiver of sovereign immunity in § 1346(a)(1). What “fully pay” means, though, is not always clear.

In Flora, the case that established the full payment rule, the facts were simple.  The petitioner claimed ordinary losses.  The Commissioner treated the reported losses as capital, resulting in a $28,908.60 deficiency.  The petitioner paid $5,058.54 of the alleged deficiency and filed a refund claim for that amount with the IRS.  Once denied, the petitioner sued in district court for a refund of the $5,058.54 and a judgment abating the remainder of the assessment.  Recognizing a circuit split and a need for uniform treatment of similar district court suits, the Supreme Court agreed to hear the case.  In the interest of saving “the harmony of our carefully structured . . . system of tax litigation,” the Court ruled that in order to obtain jurisdiction, a tax liability must be fully paid before commencing a refund suit in district court.  The petitioner lost because he had paid only the $5,058.54 portion of the $28,908.60 deficiency.

Flora, at its core, is a decision about statutory interpretation.  Faced with ambiguous language, the Court resorted to legislative history to determine the meaning of “any internal-revenue tax.” 28 U.S.C. § 1346(a)(1).  That history, the Court determined, made it more likely that Congress intended the language to mean that the entirety of a tax must be paid for jurisdiction to arise.  In Flora’s case, this meant paying the entire deficiency assessment relevant to the dispute at hand.

The Burns’ case presented complicated facts.  At the time the Burns filed their 1040X, they owed nothing to the IRS.  In fact, they already collected a refund when originally filing the return.  While the Burns reported a $70 self-employment tax on their amended return, the nearly $7,000 in credits drowned the small self-assessment.  The IRS failed to deny the claimed credits or request additional documentation.  Instead, the IRS ignored the credits, assessed the $70 self-employment tax, and hid behind Flora to attempt to dismiss the refund suit, despite failing to deny or request additional information pertaining to the credits that swallowed the assessment.

The Clinic filed a response to the DOJ’s Motion to Dismiss.  The response differentiated the Burns’ case from Flora and its subsequent progeny on two bases: first, the Burns solely disputed the denial of rightfully claimed credits of the “tax” imposed under IRC § 1.  They did not dispute the unpaid self-employment tax assessment under § 1401.  Second, the Burns had already fully paid the $70 self-employment tax with their $7,000 of deemed refundable credits.

The First Distinction: The Owed Tax and the Refundable Tax are Different “Taxes” under § 1346(a)(1)

Our response argued that the statute’s use of the words “any internal-revenue tax” allows a petitioner to file a refund suit for one type of “internal-revenue tax,” while owing another type of “internal-revenue tax.”  Our argument pointed to several different types of internal-revenue taxes throughout Title 26 of the United States Code, such as §§ 1 (individual income tax), 11 (corporate income tax), 59A (base erosion and anti-abuse tax), etc. Similarly, Flora and the language of § 1346(a)(1) does not bar tax refund suits for a given year where a taxpayer has fully paid one tax period, but owes the government on another tax period.  By the same logic, the statutory language should not bar a petitioner from refund suits where the taxpayer has fully paid one “internal-revenue tax,” but not a separate, undisputed tax. 

Looking first to the text of 28 U.S.C. § 1346(a)(1), we argued that “[t]he term ‘any’ should be given [a] broad construction under the settled rule that a statute must, if possible, be construed in such fashion that every word has some operative effect.” Jove Eng’g, Inc. v. I.R.S., 92 F.3d 1539, 1554 (11th Cir. 1996) (citing United States v. Nordic Village, 503 U.S. 30, 36 (1992) (internal citations omitted)).  Assuming a broad construction of the term “any,” we contended that the contested credits were analytically distinct from the uncontested self-employment taxes.  The two taxes come from different chapters in Title 26 of the United States Code (“IRC”), with separate analyses and calculations.  The CTC and EITC fall under Chapter 1, whereas the self-employment tax falls under Chapter 2.

Flora, on the other hand, completely concerned an IRC § 1 tax.  Flora and its progeny do not contemplate jurisdiction when the petitioner challenges an entirely separate tax than the one creating the alleged deficiency.  Further, the tax creating the alleged deficiency would be eliminated if the Burns succeeded in their case and received their refundable CTC and EITC.  In Flora, the petitioner only paid a portion of his § 1 taxes, then sought a refund for those § 1 taxes paid, with a large § 1 tax deficiency outstanding.  The Burns paid the entirety of the § 1 tax disputed in the lawsuit, which was statutorily distinct from the unpaid, undisputed § 1401 (self-employment) taxes.

We focused primarily on two cases to deliver this point.  The first, Moe v. United States, No. CS-96-0672-WFN, 1997 WL 669955 (E.D. Wash. June 30, 1997), directly took on this distinction, stating that requiring payment of both § 1 and § 1401 taxes “places form over substance,” when the taxes pertinent to the disputed issue were paid.  In Moe, the taxpayer sought a refund with respect to his § 1401 (self-employment) taxes, while he owed taxes under § 1.  While the court granted the defendant’s motion to dismiss on other grounds, it clearly found the plaintiff’s argument persuasive, stating “[p]laintiff[s] should arguably not be required to prepay the uncontested income tax portion of her 1991 tax deficiency in order to litigate the contested 1991 self-employment tax.”  We also relied on Shore v. United States, 9 F.3d 1524 (Fed. Cir. 1993), which allowed the Court of Federal Claims to hear a refund suit even though interest on the underlying tax had not been paid.  The Shore court reasoned that because the interest was not itself disputed in the refund claim or in court, it need not be fully paid prior to filing suit.

The Burns never owed tax under § 1 for 2014.  They claimed refundable credits, causing an overpayment, which they claimed as a refund.  They were never audited or received a deficiency assessment.  Indeed, they never became subject to a tax assessment until the Government ignored their claimed refundable credits in the amended return.  While the Burns owed a tax under § 1401, this was a separate “internal-revenue tax,” which the Burns did not dispute in court.  We argued that, following the statutory interpretation in cases such as Moe and Shore, the Burns passed the statutory hurdles to jurisdiction.

Second Distinction: The Refundable Credits Claimed on the Amended Return Exceed the Tax Reported on the Return

The gist of this distinction is simple: there is no deficiency that needs to be fully paid because the credits claimed outweigh the increased self-employment assessment.  Flora preceded refundable credits in general, let alone the specific CTC and EITC at issue in the Burns’ case.  Thus, Flora could not contemplate the facts in the Burns case.  However, such refundable credits should, reasonably construed, constitute payments of tax that can, in circumstances such as in this case, provide jurisdiction for a District Court to adjudicate a substantive dispute as to the taxpayer’s entitlement to those credits.

In our response, we analogized the refundable EITC and CTC to withholding credits.  By example, we described a situation where a taxpayer neglects to include a W-2 in their tax return, notices it, then attempts to file an amended return to correct the error. If the W-2 produced additional tax of $150, but reported withholdings of $200, the Government surely could not assess the $150 tax, ignore the $200 withholding, and seek dismissal of a refund suit because the taxpayer failed to fully pay the associated tax assessment.  In that example, the government already has $50 owed to the folks amending their return.  Similarly, the government already owed nearly $7,000 to the Burns.  How could the government seek dismissal based on a $70 self-employment assessment when the government owes that same taxpayer nearly $7,000 for the same tax period?  We argued that the withholding credits and the credits in our case were analogous, and thus considering these claimed refundable credits, the tax was fully paid.

Conclusion

After the court received our response, the DOJ contacted us to offer a compromise.  The DOJ proposed a stay in the case while the IRS investigated the authenticity of the claimed credits.  The Burns agreed, and the IRS ultimately agreed that the Burns qualified for the claimed CTC and EITC.  The IRS’s issuance of the refund marked the end of the Burns’ district court case, leaving the unique distinctions in the case unaddressed.  The Burns case demonstrates the ambiguity that remains nearly 60 years after the Supreme Court interpreted 28 U.S.C. § 1346(a)(1) to require full payment in order to establish district court jurisdiction with respect to tax refund claims.

Filed Under: Earned Income Credit, Flora, refund claim Tagged With:

Assessable Penalties Do Not Violate Due Process

August 26, 2019 by Leave a Comment

In Interior Glass Systems, Inc. v. United States, No. 17-15713 (9th Cir. 2019) the court held that a taxpayer against whom the IRS had assessed an IRC 6707A listed transaction penalty could not have the penalty abated on the basis that the pre-litigation assessment and collection of the penalty violated due process.  The decision does not break new ground and in some respects the appeal of this issue surprised me because I thought the law well settled here.  In part, I write about this case because the first factor of the three factors the court uses to analyze whether a violation of due process exists, intrigues me when applied to cases such as the case of Larson v. United States, 888 F.3d 578 (2nd Cir. 2017) blogged here.

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The company joined a Group Life Insurance Term Plan to fund a cash-value life insurance policy owned by its sole shareholder and only employee.  The IRS applied the tests in Notice 2007-83 in determining that participating in the cash-value life insurance policy involved a listed transaction.  Because the taxpayer did not alert the IRS of its participation in a listed transaction, the IRS imposed three $10,000 penalties, one for each year of participation, pursuant to IRC 6707A(a).  The taxpayer paid the $30,000 and sued for a refund of the money paid on the penalties.  The taxpayer’s first and perhaps primary argument addressed the application of the listed transaction provisions to the facts of its case.  Taxpayer argued unsuccessfully that it was not a listed transaction.

The taxpayer’s second argument concerned due process.  The 6707A penalty is one of many assessable penalties added by Congress in the last few decades.  Once the IRS determines that the taxpayer has engaged in the activity controlled by the penalty, Congress authorized the IRS to assess the penalty prior to giving the taxpayer the opportunity to litigate the correctness of the penalty in a pre-assessment setting.  Assessable penalties allow the IRS to move quickly to impose a liability on what it perceives as wrongdoing but the process also causes the taxpayer to lose the opportunity to judicially contest the matter without first paying the penalty (or for some divisible penalties a portion of the penalty.

The 9th Circuit cites to Flora v. United States, 362, U.S. 145, 177 (1960) for the proposition that the taxpayer first had to pay the penalty in order to get into court.  It then provides the general rule that the “government may require a taxpayer who disputes his tax liability to pay upfront before seeking judicial review.  Standard stuff.  In support of its statement that the government can require a taxpayer to pay first before litigating, the court cites Phillips v. Commissioner, 283 U.S. 589, 595 (1931) as well as one of its own cases Franceschi v. Yee, 887 F.3d 927, 936 (9th Cir. 2018).  It points to Jolly v. United States, 764 F.2d 642 (9th Cir. 1985) as establishing a three-factor test based on Mathews v. Eldridge, 424 U.S. 319 (1976) for deciding whether a taxpayer is “entitled to pre-collection judicial review of a tax penalty.

Factor one concerns “the private interest that will be affected by the official action.”  With respect to this factor, the 9th Circuit finds that the taxpayer’s private interest will not significantly suffer since the post-deprivation proceedings will provide full retroactive relief if the taxpayer prevails in its refund suit.  The court says this is not a case in which an individual faces abject poverty in the interim citing Goldberg v. Kelly, 397 U.S. 254, 264 (1970).  That seems true in the case of Interior Glass but how does this test work in assessable penalty cases such as Larson in which the taxpayer must pay $60 or $160 million in order to bring the refund suit.  Maybe the court would say that the requirement to make such a payment would not send the taxpayer into abject poverty because the taxpayer has no possibility of making such a payment.  The Second Circuit did not apply this three factor test when asked to allow a taxpayer into court in Larson faced with the ridiculously high liability.  It seems that this test could aid a taxpayer owing a huge amount even though it did not aid Interior Glass where the amount owed was only $10,000 for each of three years.

Factor two concerns the “risk of an erroneous deprivation of the private interest.”  Here the court found that deciding if a penalty should apply did not involve a difficult task.  Instead it simply involved comparing the language of the transaction with the language of the notice regarding listed transactions in a setting in which “the IRS is therefore unlikely to err in the generality of cases.”  Further mitigating the possibility of a problem here is the opportunity the taxpayer has for an administrative appeal as the taxpayer had in Larson.  The court does not mention, and did not need to mention, that in Larson the taxpayer raised some issues that would require testimony to resolve and may not lend themselves to an easy determination.  In this same paragraph of the opinion the court extolled the benefits of this administrative opportunity to appeal and cited the Collection Due Process (CDP) cases of Lewis v. Commissioner, 128 T.C. 48, 59-60 (2007) and Our Country Home Enterprises, Inc. v. Commissioner, 855 F.3d 773, 781 (7th Cir. 2017) in which the courts turned away taxpayers seeking to use CDP as a means of litigating the merits of the liability prior to paying the tax because of their opportunity to talk with the Appeals Office.

Factor three measures the “government’s interest in retaining the full-payment prerequisite to this refund action.”  The court cited the difficulty of learning about listed transactions that taxpayers do not self-identify and how IRC 6707A encouraged voluntary disclosure of such transactions.  It went on to say this objective would be jeopardized if taxpayers had a pre-payment forum in which to litigate the proposed penalty.  I wonder why assessable penalties are more important than tax itself.  Congress gives taxpayers the right to a pre-payment forum prior to assessment of income tax.  Penalties do not seem more important to the government or its operation than income tax.

The outcome here is not surprising.  On factor one I would like to see an analysis of this factor in a case like Larson where the payment of the tax is a monetary impossibility.  Does the impossibility of making a payment cause it to slip outside something that would impact the party’s interest and therefore not impact the person from a due process perspective?

Filed Under: Abatement, Flora

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

January 7, 2019 by 3 Comments

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

 

Filed Under: FBAR, Flora

Update: Can District Courts Hear Innocent Spouse Refund Suits?

December 24, 2018 by 1 Comment

We welcome back frequent guest blogger Carl Smith. Carl discusses a case, Hockin, in which the Tax Clinic at the Legal Services Center of Harvard Law School has filed an amicus brief. If you read the brief filed by Ms. Hockin, to which we link below, you will learn the underlying facts of the case. Like the vast majority of innocent spouse cases these facts describe the sad circumstances that led her to request relief. Relief here for her, if she obtains it, will not make her whole monetarily because of the Flora rule. (Of course, relief would never make her whole in the true sense because the tax system can only assist her with the tax component of the difficult situation caused by the actions of her former husband.) 

This case should not only make us think about the jurisdictional issues raised by the innocent spouse provisions but also about how the application of the Flora rule prevents taxpayers without the wherewithal to fully pay in a short span of time to obtain the return of all of the money paid to the IRS for taxes that they do not owe. This situation describes most low income taxpayers. Keith

This is an update on two cases discussed by Keith in a recent post. The post primarily discussed the case of Chandler v. United States, 2018 U.S. Dist. LEXIS 174482 (N.D. Tex. Sept. 17, 2018) (magistrate opinion), adopted by judge at 2018 U.S. Dist. LEXIS 173880 (N.D. Tex. Oct. 9, 2018). Chandler was a district court suit in which an individual sought a refund for overpaying her equitable share of taxes on a joint return, taking into account innocent spouse relief under section 6015(f). In Chandler, the district court granted a DOJ motion to dismiss for lack of jurisdiction, holding that only the Tax Court could hear suits involving innocent spouse relief. Keith wondered whether there would be an appeal of this ruling of first impression with respect to innocent spouse refund suit jurisdiction.

In his post, Keith also mentioned the existence of a similar innocent spouse refund suit under section 6015(f) pending in the district court for the District of Oregon, Hockin v. United States, Docket No. 3:17-CV-1926. In that case, a similar DOJ motion to dismiss for lack of jurisdiction was pending, arguing that district courts cannot hear refund suits involving innocent spouse relief.

The update, in a nutshell, is that Chandler was not appealed, but Hockin has been set up as a test case, where nearly all the filings are in and linked to below.

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Both under the original innocent spouse provision (section 6013(e), which existed from 1971 to 1998) and the current innocent spouse provision (section 6015, enacted in 1998), the district courts and the Court of Federal Claims had occasionally, and without objection from the DOJ, entertained suits for refund filed solely on the grounds that a taxpayer paid more than was required after the application of the innocent provisions.

Although the DOJ had apparently never done so before in any innocent spouse refund suit going back all the way to the 1970s and 1980s, in the summer of 2018, DOJ trial division lawyers in both Chandler and Hockin submitted motions to dismiss for lack of jurisdiction, arguing that, because Congress in 1998 enacted a stand-alone innocent spouse Tax Court action at section 6015(e) in which the Tax Court can find an overpayment under section 6015(b) or (f), the Tax Court is the sole court in which innocent spouse refund suits can now be filed (i.e., via section 6015(e)), and so neither the district courts nor the Court of Federal Claims has jurisdiction to entertain innocent spouse refund suits. The DOJ motions acknowledged only one rare exception to this position: Where there was a pending refund suit in a district court or the Court of Federal Claims (presumably on other issues) at a time when a taxpayer also filed a suit in the Tax Court under section 6015(e), the statute provides that the Tax Court innocent spouse suit should be transferred over to the court hearing the refund suit. Section 6015(e)(3).

In July, Keith and I were alerted to the existence of the motion in Hockin – but not the one in Chandler – by pro bono counsel for Ms. Hockin, J. Scott Moede, the Chief Deputy City Attorney of the Portland, Oregon Office of the City Attorney. Mr. Moede had taken on the Hockin case in his role as a regular voluteer with the Lewis & Clark Low-Income Taxpayer Clinic in Portland. That clinic suggested that Mr. Moede contact the Harvard Federal Tax Clinic because of the Harvard clinic’s interest in innocent spouse cases.

Working with summer students, in August, Keith and I put together a draft of a proposed amicus memorandum for Hockin arguing that the DOJ position was both ahistorical and contrary to the 1998 and 2000 legislative history of section 6015(e) that seemed to make clear that Congress enacted section 6015(e) to be added on top of all existing avenues for judicial review of innocent spouse issues, not to repeal or replace any prior avenues for judicial review.

Further, in the draft memorandum, we pointed out that the Trial Section’s motion in Hockin took a position directly contrary to the position that the DOJ Appellate Section had taken in three cases that the Harvard clinic had recently litigated. In those three cases, the DOJ Appellate Section urged the appellate courts not to worry about holding that a person who filed a late Tax Court suit under section 6015(e) must have her suit dismissed for lack of jurisdiction. The DOJ Appellate Section said that such a taxpayer could always still get judicial review of the IRS’ decision to deny innocent spouse relief by paying the tax in full, filing a refund claim, and suing for a refund in the district court or the Court of Federal Claims.

In both Hockin and Chandler, the taxpayers received a notice of determination denying innocent spouse relief, but did not try to petition the Tax Court within the 90 days provided under section 6015(e). Rather, after later making either partial (Chandler) or full (Hockin) payment, the taxpayers filed refund claims and brought refund suits in district court that were timely under the rules of sections 6511(a) and 6532(a) (though, for Hockin, the lookback rules of section 6511(b) limit the amount of the refund to only a portion of what Ms. Hockin paid). Thus, except for the full payment (Flora) rule problem in Chandler, the taxpayers had done exactly what the Appellate Section said they should do to get judicial review of innocent spouse relief rulings other than through section 6015(e).

In August, we sent a draft copy of the memorandum to the DOJ attorney in Hockin and asked whether the DOJ would object to a motion by the Harvard clinic to file it. This draft memorandum apparently triggered the DOJ’s desire to explore mediation in the case. So, the case was assigned to a magistrate for mediation, and further filings on the motion (including the amicus motion) were postponed.

Then, in September and October, the magistrate and district court judge, respectively, issued rulings in Chandler granting the DOJ’s motion to dismiss for lack of jurisdiction. That is how Keith, Mr. Moede, and I learned of the existence of the Chandler case presenting the identical jurisdictional issue. Although Ms. Chandler was represented by counsel, that counsel had filed no papers in response to the DOJ motion to dismiss in her case. Naturally, this led to the magistrate and judge in Chandler relying entirely on the DOJ’s arguments and citations in ruling for the DOJ.

In his recent post on Chandler, Keith raised the question whether the Chandler district judge ruling would be appealed to the Fifth Circuit. The first piece of news in this update is that Ms. Chandler decided not to appeal. Frankly, give the Flora full payment problem in the case, I think an appeal on the issue of whether the district court otherwise would have had jurisdiction would have been pointless.

But, the second piece of news is that, in November, mediation failed in the Hockin case. So, Hockin is now set up as a possible appellate test case, depending on the district court’s ruling.

The DOJ has now not objected to the Harvard clinic’s filing of an amicus memorandum in Hockin. That memorandum was filed on November 26.

On December, 21, Ms. Hockin (through Mr. Moede) filed her response to the DOJ motion. In her response, Ms. Hockin argued not only that the district court had jurisdiction over section 6015 innocent spouse relief refund suits, but also that she had raised in her refund claim two additional arguments: that she had never filed a joint return for the year and that the IRS should be bound to give her innocent spouse relief for the year because it had given her such relief for the immediately-following taxable year. As noted in the Harvard memorandum, the “no joint return” argument has been considered in district court refund lawsuits even predating the enactment of the first innocent spouse provision in 1971.

The DOJ will be allowed to file a reply by January 11.

On February 5, oral argument on the motion will be heard before a magistrate who was not involved in the mediation. Ms. Hockin has agreed to have this magistrate decide the jurisdictional motion without the involvement of a district court judge, but the DOJ has not yet similarly consented. If the DOJ does the same, and the magistrate dismisses the case, this would allow a direct appeal from the magistrate to the Ninth Circuit. If the DOJ does not consent, the magistrate’s ruling will have to be reviewed by a district court judge before a party could appeal any adverse ruling to the Ninth Circuit.

You can find here for Hockin, the DOJ’s motion, the Harvard clinic’s amicus memorandum, and Ms. Hockin’s response.

Finally, you may be aware of the recent amendment of 28 U.S.C. section 1631 that allows district courts and the Court of Federal Claims to transfer to the Tax Court suits improperly filed in the former courts. That amendment would not help Ms. Hockin, since her district courts suit was filed long after the 90-day period to file a Tax Court suit under section 6015(e) expired. So, her case, if transferred, would have to be dismissed by the Tax Court for lack of jurisdiction because the suit was untimely filed in the district court for purposes of the Tax Court’s stand-alone innocent spouse case jurisdictional grant. For Ms. Hockin, her only chance now for getting a refund attributable to the innocent spouse provisions is for the courts to agree that district courts have jurisdiction to consider innocent spouse refund suits.

 

Filed Under: Flora, Innocent Spouse Tagged With:

Larson Part  2: Absence of Prepayment Judicial Review Is Not a Constitutional Defect

May 10, 2018 by 3 Comments

Carl Smith’s earlier post on Larson v United States discussed Larson’s argument that the Flora rule should not apply to immediately assessable civil penalties under Section 6707. Larson also argued that the absence of prepayment judicial review violated his 5th Amendment procedural due process rights.

I will briefly describe the procedural due process issue and the Second Circuit’s resolution of the issue in favor of the government.

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Larson’s argument Larson was straightforward: the absence of judicial prepayment review of the 6707 penalty violated his right to procedural due process, a right embedded in the 5thAmendment. The 5thAmendment provides that no person shall be . . . deprived of life, liberty, or property, without due process of law . . . .”  Stated differently, Larson argued that the right to challenge the penalty prior to payment at Appeals was not enough to meet constitutional due process standards. Taking the constitutional gloss off of it, as the opinion states, Larson felt that the process “just wasn’t fair.”

The Second Circuit disagreed in a fairly brief discussion of the issue, and in so doing reminds us that while courts have pushed back on tax exceptionalism in many areas, when it comes to viewing the adequacy of IRS procedures in a due process framework tax is different.

At its heart, the protections associated with procedural due process, notice and hearing, are about minimizing the risk of the government making a mistake and depriving a person of a protected interest—in this case property. In finding that the process adequate, the Larson opinion leaned on caselaw that had its pedigree in 17thcentury England which had established that when assessing and collecting taxes the sovereign is entitled to rely on summary pre-payment and assessment procedures backstopped by the right to post payment judicial review.

That case law was based on the notion that potentially interposing a hostile judiciary between the taxpayer and the fisc was just too risky; taxes, after all, are the lifeblood of the government, and if the government makes a mistake in assessing a tax, a taxpayer can get justice by bringing a refund suit.

Of course, in our modern tax system, Congress has repeatedly stepped in and provided statutory protection to allow prepayment review in many cases. The US Tax Court exists in large part to soften the impact of the lack of meaningful due process protections associated with a determination of liability. The ability to pay a divisible portion of a tax and sue for refund, as well as CDP’s opportunity to challenge a liability in certain circumstances, all soften the blow of the exceptional view of tax cases.

As Carl mentioned the 6707 penalty is not divisible, and we have discussed the limits of CDP providing a forum for challenging the penalty.

This brings us to Larson’s constitutional challenge.  As Larson and others have argued, much has happened since the Supreme Court first blessed the assess first pay later constitutionality of the US tax system in the latter part of the 19thand early part of the 20thcentury. A number of meaningful Supreme Court cases, such as Goldberg v Kelly, provided that in most instances, the norm should be more defined pre-deprivation review. Most creditors are no longer entitled to rely on post payment judicial protections to ensure that a debtor’s interests are protected. In Mathews v Eldridge, the Supreme Court instructed courts to consider three factors when faced with a due process claim: (1) “the private interest that will be affected by the official action”; (2) “the risk of an erroneous deprivation of such interest through the procedures used, and the probable value, if any, of additional or substitute procedural safeguards”; and (3) “the Government’s interest, including the function involved and the fiscal and administrative burdens that the additional or substitute procedural requirement would entail.

In concluding that Larson did not have a successful procedural due process claim, the court did acknowledge that the Mathews factors were instructive and did in fact apply those factors to Larson’s facts. That  is more than some courts have done with tax cases, where some opinions state that since the time of King Charles the sovereign is entitled to rely on summary assessment procedures, and leave it at that.

In applying Mathews, the opinion stated that on balance while Appeals might not have afforded a perfect process the taxpayer did get a major reduction in the penalty assessment, and, in any event, the government interest in tax cases is “singularly significant”:

Larson’s interest is not insignificant; the IRS has imposed onerous penalties that Larson claims he cannot pay. But, as we previously noted, the IRS Office of Appeals review resulted in a substantial reduction of Larson’s penalties. No review is perfect and Larson offers no record‐based criticism of how the appeal was conducted. We are satisfied that the current procedures effectively reduced the risk of an erroneous deprivation and gave Larson a meaningful opportunity to present his case. Indeed, the Seventh Circuit recently observed that the IRS Office of Appeals “is an independent bureau of the IRS charged with impartially resolving disputes between the government and taxpayers,” and that “Congress has determined that hearings before this office constitute significant protections for taxpayers.” Our Country Home Enters., Inc., 855 F.3d at 789. Lastly, the governmental interest here is singularly significant due to the careful structuring of the tax system and the Government’s “substantial interest in protecting the public purse.” Flora II, 362 U.S. at 175. Considering all three factors, our Mathewsanalysis weighs in the Government’s favor. Therefore, application of the full‐payment rule to Larson’s § 6707 penalties does not result in a violation of Larson’s due process rights.

Observations and Conclusion

The opinion leans heavily on Appeals’ role, both in terms of how Congress has emphasized Appeals’ importance to the tax system (an issue front and center in the Facebook litigation we have discussed) and how Appeals reduced the penalties at issue in the case by $100 million.  The opinion heavily weighs the government’s interest without thinking on a more granular level as to what the government interest is. For example, what is the government’s interest in summary process for this penalty? What additional burdens or risks would the government face by allowing for judicial review of the penalty? I also would have liked to have seen a more robust discussion of the individual’s interest and a bit more on the structural deficiencies with Appeals as a resolution forum relative to a judicial forum.

To be sure, due process is not a one size fits all analysis. And as a comment to Carl’s post notes perhaps Larson is not the most sympathetic of taxpayers. Yet, over time, our tax system has changed to reflect an increased sense that taxpayers should have the right to challenge an IRS assessment without having to full pay the liability. Congress has also added significant civil penalties that are immediately assessable; that progression has been piecemeal and could stand to use some reform that might also consider the procedural aspects of challenging those penalties.

Norms with respect to individual protections and taxpayer rights are changing as well. Perhaps the appropriate remedy here is a statutory fix to CDP that would allow for Tax Court review of the penalty and possible refund of any amount paid in a CDP proceeding. That would more closely align collection due process with the 5thAmendment notion of due process.

 

Filed Under: Civil Penalties, Flora
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