Larson Part I Post: Full-Payment Rule of Refund Suits Held to Apply to Assessable Penalties

Frequent contributor Carlton Smith discusses last month’s Larson v United States out of the Second Circuit. The Larson opinion situates civil penalties in the context of the Flora full payment rule, the APA, the 5th Amendment’s procedural due process protections and the 8th Amendment’s prohibition on excessive fines. Today’s post looks at the Flora full payment issue. Future posts will address the other issues. Les

In Flora v. United States, 357 U.S. 63 (1958) (“Flora I”), and, again, in an expanded opinion at 362 U.S. 145 (1960) (“Flora II”), the Supreme Court held that a jurisdictional predicate to a district court or Court of Federal Claims suit under 28 U.S.C. § 1346(a)(1) for refund of an income tax deficiency is full payment of the tax deficiency.  In oral argument in a later Supreme Court case, Laing v. United States, 423 U.S. 161 (1976), the Solicitor General’s office made clear its position that Flora’s full payment requirement only applies where the taxpayer could have, instead, petitioned the Tax Court to contest the deficiency prepayment, but chose not to.  A recent opinion, Larson v. United States, 2018 U.S. App. LEXIS 10418 (2d Cir., Apr. 25, 2018), involved a tax shelter promoter penalty assessed under section 6707 – one of the many “assessable” penalties that Congress has enacted since Flora that may be assessed without first allowing prepayment review in Tax Court through a notice of deficiency.  In Larson, the DOJ argued contrary to what the SG’s office did in Laing, and the Second Circuit accepted this changed position – holding that the Florafull payment requirement also applies to assessable penalties for which there is no possibility of Tax Court prepayment review through deficiency procedures.


Larson Facts

The facts of Larson were as follows:  Larson was criminally convicted in connection with promoting several tax shelters.  The IRS later decided to impose assessable penalties under section 6707 for the promoters’ failure to file the necessary form under section 6111 (Form 8918) with the Office of Tax Shelter Analysis in Ogden, Utah alerting the IRS to the shelters.  Under section 6707 at the time (though not currently), the penalty under section 6707 was calculated as 1% of “the aggregate amount [that taxpayers] invested in such tax shelter”.

The IRS proposed to assess penalties of $160 million on a collection of promoters (including Larson), jointly and severally.  This means that the “aggregate amount invested”, according to the IRS, was $16 billion.

Other promoters paid the IRS about $100 million toward the penalty.  Larson contested the $160 million penalty at Appeals, arguing that the amount actually invested in the shelters in cash was only about $700 million, meaning the total penalty should be $7 million.  The rest “invested” was through notes that the courts had now held to be bogus for income tax purposes, so he argued that they were bogus, as well, for purposes of calculating the penalty.  (Of course, the taxpayers must have used those bogus notes to inflate their bases for purposes of claiming deductions far beyond the cash they invested.)

Appeals did not agree with Larson’s argument for lowering the penalties to $7 million, though it did give him credit for the penalties already paid by other promoters, reducing what Larson owed to about $60 million.

Larson District Court Suit

Larson paid $1.4 million toward the penalties, filed a refund claim, and then sued for a refund in the district court of the Southern District of New York.  It is not clear why he paid $1.4 million, but it appears that he thought the section 6707 penalty was “divisible”, and that $1.4 million was enough payment of a divisible tax to give the court jurisdiction.  In a footnote in Flora II, the Supreme Court said that full payment would not be required if a divisible tax was involved — a footnote that many people take advantage of with respect to section 6672 responsible person penalties (which have been held to be divisible).

In his suit, Larson argued that he had made a sufficient jurisdictional payment to commence suit, but that, even if he did not, the court had alternative jurisdiction under the Administrative Procedure Act, mandamus, Due Process, and because the size of the penalty violated the Eight Amendment’s excessive fines clause.

Unfortunately for Larson, shortly after he commenced his suit, the Federal Circuit held in Diversified Group Inc. v. United States, 841 F.3d 975 (Fed. Cir. 2016), that the section 6707 penalty was not divisible, so Flora IIrequired full payment in order to commence a refund suit.  The district court in Larson cited and followed Diversified Group, also rejecting all the other bases for jurisdiction that Larson alleged.  Larson v. United States, 2016 U.S. Dist. LEXIS 179314 (SDNY 2016).  Stephen did a prior post on both Diversified and the Larson district court opinion.

This post will not address the other grounds alleged for jurisdiction, but Les will be doing a later post on at least one of those other grounds.

Larson Appellate Arguments

 In his Second Circuit Appeal, Larson repeated all of his arguments for why the district court had jurisdiction, but abandoned his argument that section 6707 penalties are divisible.  Rather, Larson’s main argument was now that Flora II did not require full payment in a case like section 6707 penalties where no prepayment review was available in the Tax Court through a notice of deficiency.  Larson also argued that he couldn’t afford to pay the roughly $60 million left to make full payment, so requiring him to make full payment would leave him without a practical remedy for judicial review.

Flora II

Flora II expanded upon the opinion in Flora Iand corrected a significant misstatement in the earlier opinion.  Hereafter, I will discuss only Flora II.  In Flora II, the IRS had sent the taxpayer a notice of deficiency for income tax.  He did not file a Tax Court petition, but rather paid part of the deficiency, filed a refund claim, and brought suit for refund in district court. The Supreme Court held that a jurisdictional predicate to a refund suit under 28 U.S.C. § 1346(a)(1) is full payment of the tax.  But, the way it got to this holding was curious.

The statute being interpreted first appeared in the Revenue Act of 1921.  But, the court found that, even though there were statutory antecedents, with regard to whether full payment is required for a refund suit, the actual “statutory language . . . is inconclusive and legislative history . . . is irrelevant”.  Flora II, 362 U.S. at 152.

So, the Court then turned to three subsequent enactments of Congress to conclude that section 1346(a)(1) required full payment:

  • The establishment of the Board of Tax Appeals in 1924, which allowed taxpayers to contest deficiencies without prepayment, seemed to be done with the assumption that the Board was needed because refund suits concerning deficiencies otherwise required full payment.
  • In 1935, Congress amended the Declaratory Judgment Act (28 U.S.C. § 2201) to prohibit declaratory judgments “with respect to taxes”. The Court noted that if full payment were not required, then nothing would stop a taxpayer from paying $1, filing a refund claim, and suing for a refund. The latter would effectively be a suit for a declaratory judgment.
  • The adoption of section 7422(e), which provides that, if a refund lawsuit is underway when the taxpayer receives a notice of deficiency for the same taxable year, the taxpayer may either continue the suit in district court or move it to the Tax Court, but not litigate simultaneously in both courts.The Court concluded that the logic of not requiring full payment for a refund suit would be that a taxpayer could simultaneously conduct a deficiency suit in the Tax Court and a refund suit in the district court – a situation that section 7422(e) does not contemplate.

The Flora II court concluded with the following observation:

A word should also be said about the argument that requiring taxpayers to pay the full assessments before bringing suits will subject some of them to great hardship.  This contention seems to ignore entirely the right of the taxpayer to appeal the deficiency to the Tax Court without paying a cent.  If he permits his time for filing such an appeal to expire, he can hardly complain that he has been unjustly treated, for he is in precisely the same position as any other person who is barred by a statute of limitations.

362 U.S. at 175 (footnote omitted).


Laing v. United States, 423 U.S. 161(1976), involved income tax termination and jeopardy assessments under section 6851 and 6861 at a time when those sections did not state that the IRS must issue a notice of deficiency in connection with making such assessments.  The IRS had made such an assessment and argued that it was not required to issue a notice of deficiency before or after the assessment.

At the oral argument, the Solicitor General’s Office assured the Court that there would be no problem with the FloraII full payment rule, since Flora II did not require full payment if no deficiency notice could be sent to the taxpayer.  Here is a portion of the SG’s office oral argument that was quoted to the Second Circuit on page 6 of the Larson reply brief:

What this Court held in Flora was that under general circumstances a taxpayer cannot bring a refund suit until he has paid the full amount of the assessment.  In reaching that decision, the Court painstakingly went through the legislative history in connection with the creation of the Board of Tax Appeals, and there were indications going both ways as to what Congress really intended.  But I think that the really operative portion of the Chief Justice’[s] opinion in Flora was the fact that there the taxpayer had another remedy.  He could have gone to the Tax Court, and that made all the difference in Flora . . . .

For those interested, attached are all the briefs filed in Larson:  the appellant’s brief, the appellee’s brief, the reply brief(which contains the entire Laing oral argument transcript as an addendum), and an amicus brieffiled by the tax clinics at Harvard and Georgia State.  I believe that Keith will be doing a further post about what the amicus brief discussed.

The majority in Laing held that the IRS was required to send a notice of deficiency, so it did not reach the issue of whether Flora II required full payment for a refund suit in the absence of the possibility of receiving a notice of deficiency.

But, Justice Blackmun (joined by Chief Justice Berger and Justice Rehnquist) wrote a lengthy dissent in which he argued that no notice of deficiency was required in connection with a termination or jeopardy assessment.  However, he concluded that the taxpayer could bring suit in district court without full payment of the assessment.  After quoting part of the quote that I have quoted above from Flora II, Justice Blackmun wrote:

This passage demonstrates that the full-payment rule applies only where a deficiency has been noticed, that is, only where the taxpayer has access to the Tax Court for redetermination prior to payment.  This is the thrust of the ruling in Flora, which was concerned with the possibility, otherwise, of splitting actions between, and overlapping jurisdiction of, the Tax Court and the district court.  Where, as here, in these terminated period situations, there is no deficiency and no consequent right of access to the Tax Court, there is and can be no requirement of full payment in order to institute a refund suit.

423 U.S. at 208-209 (citation omitted).

Larson Second Circuit Ruling

In its opinion in Larson, the Second Circuit held that Flora II required the full payment of the section 6707 penalty before a refund suit could be brought.  It quoted the passage from Flora IIthat I have quoted above, yet argued that the availability of Tax Court deficiency review was not critical to the holding of Flora II.  The Second Circuit wrote:

While it is true that Flora I and Flora II acknowledge the existence and availability of Tax Court review, see Flora I, 357 U.S. at 75–76; Flora II, 362 U.S. at 175, Tax Court availability was not essential to the Supreme Court’s conclusion in either opinion.  The basis of the Flora decisions is that when Congress enacted § 1346(a)(1) it understood the statute to require full‐payment to maintain “the harmony of our carefully structured twentieth century system of tax litigation,” not that the full‐payment rule only applies when Tax Court review is available. Flora II, 362 U.S. at 176–77.

Slip op. at 10.

The Larson court did not acknowledge that the government had changed position as to the applicability of the full payment rule between Laingto Larson.  The Larson court did quote Justice Blackmun’s statements from his dissent in Laing, but noted:  “Justice Blackmun’s view did not garner majority support.  No subsequent majority of the Supreme Court has adopted that understanding of the statute.” Slip op. at 12 n.8.

As more evidence that full payment was required to commence the section 6707 refund suit, the Second Circuit noted that other assessable penalties have been enacted by Congress since Flora II with specific provisions that allow for payment of 15% before a refund suit can be commenced.  (“[O]ur reading is supported by Congress’s decision to provide partial payment review for other assessable penalties, but not for § 6707. See 26 U.S.C. §§ 6694(c), 6703(c).”  Slip op. at 8.)

After rejecting the other bases alleged by Larson for jurisdiction (which I won’t discuss here), the court concluded that this is a problem for Congress, writing:

We close with a final thought.  The notion that a taxpayer can be assessed a penalty of $61 million or more without any judicial review unless he first pays the penalty in full seems troubling, particularly where, as Larson alleges here, the taxpayer is unable to do so.  But, “[w]hile the Flora rule may result in economic hardship in some cases, it is Congress’ responsibility to amend the law.”  Rocovich v. United States, 933 F.2d 991, 995 (Fed. Cir. 1991).

Slip op. at 22.


The most surprising thing about the Larson opinion, to me, is that this issue of Flora’s application to assessable penalties has not been litigated before – i.e., until about 60 years later.  But, then most assessable penalties are either severable, require only 15% payment to commence suit, or are rather nominal in amount, so there were few in a position to argue that a full payment requirement to commence an assessable penalty refund suit was neither required by Flora II nor economically practicable.

The second most surprising thing is that both Flora II and Larson defend their statutory interpretation exclusively by reference to understandings of later Congresses when legislating.  I have always read that one is not to pay much attention to what later Congresses think a statute means.

But, ultimately, I was not surprised at the Larson ruling, and I don’t think Keith was either. I refer people to my statutory proposal made some years ago:  “Let the Poor Sue for a Refund Without Full Payment”, Tax Notes Today, 2009 TNT 191-4 (Oct. 6, 2009).  Although my proposal was designed primarily for the poor, it would help Larson (assuming that he gets himself on an installment agreement or in currently not collectible status first).  The opinion in Larson just underscores the need for a legislative fix.

Flora and Preparer Penalties: Preparer Two Weeks Late to File Suit in District Court

As we move into tax season, it is worth remembering that IRS has a significant arsenal of civil and criminal penalties to address misbehaving preparers. I recently came across a federal district court case, Bailey v. United States that discussed an exception to the Flora full payment rule for preparers subject to penalties for preparing tax returns or refund claims that have understatements stemming from unreasonable positions or willful/reckless conduct. For preparers, that penalty can be fairly sizeable, as under Section 6694 the amount of the penalty is the greater of $1,000 for each return or refund claim ($5,000 if the understatement is due to willful or reckless conduct) or 50% (75% for willful/reckless conduct) of the income derived by the tax return preparer with respect to the return or claim for refund.


These penalties are not subject to the deficiency procedures, meaning that if IRS examines a preparer and determines that the preparer’s conduct in preparing the return or refund claim warrants a penalty, the preparer will generally have to pursue a refund suit to guarantee judicial review of the penalty. (I’ll skip the CDP discussion on this, a topic we also have discussed, which turns on whether a preparer has previously had an opportunity to dispute the penalty through its rights to have Appeals consider the matter).

We have often discussed the Flora rule, which requires full payment to ensure jurisdiction for a refund suit. Flora presents a considerable barrier, especially for moderate income persons subject to the penalty but also stemming from the fact that some civil penalties, including the variety of penalties preparers are subject to, can be very significant; Keith has written about that before here, suggesting perhaps it is time to rethink Flora in light of the impact and potential unfairness of requiring full payment to get a court to review the Service’s penalty determination.

Bailey implicates an implicit statutory exception to Flora for the 6694 penalties. IRS asserted $70,000 in penalties due to what IRS felt was his willful or reckless conduct. As per Section 6694(c)(1), if a preparer pays at least 15% of the Section 6694 penalty within 30 days of IRS making notice and demand, the preparer can stay collection and file a refund claim. Section 6694(c)(2) also provides that if a preparer fails to file suit in district court within the earlier of (1) 30 days after the Service denies his claim for refund or 30 days of the expiration of 6 months after the day on which he filed the claim for refund, then paragraph (1) of Section 6694(c) no longer applies. That suggests that a preparer can avoid the full payment rule; to that end see note 1 of the 2016 Bailey opinion, discussing the logical Flora implication of Section 6694(c)(2).

In Bailey, the preparer paid $10,500, or 15 percent of the penalty within 30 days of the IRS notice. He filed a refund claim on March 28, 2014. At the time of the suit, IRS did not deny the claim. Thirty days after the expiration of 6 months (and a day) from the time he filed his claim was October 29, 2014. Bailey filed his refund suit in district court on November 12, 2014. That filing was two weeks late, and he no longer was eligible to take advantage of the exception to Flora.

Because the preparer missed the deadline, the district court granted the government’s motion to dismiss the suit. The failure to comply with the time requirements in Section 6694(c)(2) meant that absent the preparer’s full payment of the penalty, the district court did not have subject matter jurisdiction over the suit. Because the dismissal was without prejudice, the preparer could cure his error by fully paying the balance and refiling his complaint.

Instead of full paying, the preparer filed another action in federal court in 2017; this time, the suit alleged personal misconduct among IRS employees; in light of a motion to dismiss the preparer filed a motion to substitute the US as a party to the suit and restated his allegations that his conduct did not warrant a penalty. In November of last year the court dismissed that suit.

Additional Courts Hold Promoter Penalties Not Divisible For Refund Claim

So Flora is not an option.

In the below post, we will discuss the somewhat recent holdings in Diversified Group v. United States and Larson v. United States, two cases dealing with whether or not promoter penalties under Section 6707 are divisible for refund claim purposes.  An interesting issue, and one that may require a tweak to the law from Congress.

In September of 2015, Keith wrote about Diversified Group Inc. v United States, where the Court of Federal Claims held that shelter promoter penalties imposed under Section 6707 were not divisible, and therefore the promoter could not pay the penalty imposed on just one investor (this case was decided based on prior versions of Section 6111 and 6707, but the underlying concepts are still valid).  In November, the Court of Appeals for the Federal Circuit affirmed the Court of Federal Claims; the opinion can be found here.


As explained by Keith and in the opinion, in general, a taxpayer can only sue for a refund in a district court after the amount of tax has been paid in full.  SCOTUS created an important exception to this rule in Flora v. US, where it indicated an excise tax may be divisible based on each taxable transaction or event, allowing full payment to occur with a small amount of tax.  Under Section 6707, certain promoters who fail to file required returns, or do so with a false or incomplete return, regarding reportable transactions are subject to penalties.  The penalty then imposed was 1% of the aggregate investment amount (now the penalty is $50,000 for each transaction, or, if relating to a listed transaction, it is the greater of $200k or 50% of the gross income derived by the advisor (increased to 75% if the failure is intentional)).  The promoter paid a portion related to one transaction and sued for refund, and the IRS objected.  The lower court determined the penalty was not divisible, and was related to the singular act of failing to report the promoting of the tax shelter (and not the imposition of the amount on the 192 clients separate transactions).

The appellate court affirmed that the singular act of failing to report the shelter was what occurred to impose the penalty.  Further, it reviewed the applicable language, finding the Code viewed the shelters in the aggregate (not individually) for determining if the penalty was applied,  and Section 6111 required disclosure the day on which the shelter was initially offered, and did not relate to each investor  buying in.  Providing more evidence it was the initial failure and not each purchase of the shelter.

I quote briefly from Keith’s post regarding the direct impact of this case:

While feeling sorry for someone who promotes an egregious tax shelter scheme requires a great deal of effort, I think parties should have the opportunity to litigate the imposition of a tax or penalty without full payment.  The Court of Federal Claims decision rests on firm ground, yet barring someone against whom the IRS assesses a penalty, any penalty, from disputing that penalty in court without paying over $24 million seems inappropriate.  Maybe tax shelter promoters have access to that kind of money but most parties do not.

Keith’s post also discusses the potential for CDP as an avenue for a merit review by the courts, which is not without issues.  If readers have not previously reviewed that aspect of Keith’s prior post, I would encourage them to do so.

The Diversified holding was followed by Larson v. United States, which was decided by the District Court for the Southern District of New York on December 28th.  Larson is continued fallout from the KPMG tax shelter case from the mid-2000s.  Mr. Larson paid a fraction of the $63.4MM Section 6707 penalty related to one transaction (the overall penalty was initially a $160.2MM penalty, but others paid portions of it).  He argued that the partial payment was valid under Flora.  The Southern District came to the same conclusion as the Federal Circuit.

Jack Townsend wrote up the case on his Federal Tax Crimes Blog here, where he summarizes the holding and quotes the salient aspects of the case.  At the end of the post, Jack highlights his takeaways from the case, which include similar contents to Keith’s thoughts on Diversified.  Jack thinks, given the huge dollar amounts that can be involved, that there needs to be some prepayment or partial payment review, otherwise taxpayers could be inappropriately precluded from litigating the merits.  Mr. Larson attempted to make similar arguments in his case, based on the APA and the Constitution, which the Southern District did not agree with.  These are discussed below.

Jack also highlights an APA challenge raised by Mr. Larson.  Larson argued for judicial review under the APA claiming the denial of his refund claim was arbitrary, capricious, and an abuse of the IRS discretion.  The Court found this argument lacking, stating “an existing review procedure will…bar a duplicative APA claim so long as it provides adequate redress. Clark City Bancorp. v. US Dept. of Treasury, 2014 WL 5140004 (DDC Sept. 19, 2014)”.   The “existing review procedure” here was the full payment of  the claimed amount due, and the request for review of a refund denial in the district court.  Jack’s post highlights other language summarizing this holding.

There are various other interesting arguments made in this case.  For instance, Mr. Larson argued the fines under Section 6707 violate the 8th Amendment of the Constitution (excessive fine, not cruel and unusual punishment, although if I told my wife I owed a fine of that amount I am certain it would result in cruel and unusual punishment).  The Court questioned whether it had jurisdiction to review the matter, but eventually determined that didn’t matter, as Larson failed to state a claim.

Sticking with long shot Constitutional challenges, Mr. Larson also argued that his due process rights under the Fifth Amendment would be violated by the penalty under Section 6707 if it was not divisible because the imposition of the full payment rule would preclude him from being able to pay and therefore from being able to have a review.  The Court rejected this argument, stating courts have consistently held that the inability to pay penalties has never been determined to be a due process violation (citing to various cases, including the recent case of his one-time co-defendant, Robert Pfaff, 117 AFTR2d 2016-981 (D. Colo. 2016)).  I understand if this was not the rule, everyone would claim inability to pay, and it is possible that much lower fine amounts would clog the courts.  Here, however, the fine was $63MM!  I think less than .1% of the population would ever be able to pay that.

I have no further insight beyond what Jack and Keith stated.  For the most part, the people arguing these cases have violated the tax law, and done so knowing full well that the areas they were flirting with had substantial penalties.  They did this for significant financial gain.  But, the penalties can easily be many times more than the assets of the individual, making it impossible for full payment, and there should be some way for the merits to be litigated.  This will likely require a legislative change, although I am uncertain who is going to advocate for the tax shelter promoters.

Summary Opinions — For the last time.

This could be our last Summary Opinions.  Moving forward, similar posts and content will be found in the grab bags.  This SumOp covers items from March that weren’t otherwise written about.  There are a few bankruptcy holdings of note, an interesting mitigation case, an interesting carryback Flora issue, and a handful of other important items.


  • Near and dear to our heart, the IRS has issued regulations and additional guidance regarding litigation cost awards under Section 7430, including information regarding awards to pro bono representatives. The Journal of Accountancy has a summary found here.
  • The Bankruptcy Court for the Southern District of Florida in In Re Robles has dismissed a taxpayer/debtor’s request to have the Court determine his post-petition tax obligations, as authorized under 11 USC 505, finding it lacked jurisdiction because the IRS had already conceded the claim was untimely, and, even if not the case, the estate was insolvent, and no payment would pass to the IRS. Just a delay tactic?  Maybe not.  There is significant procedural history to this case, and this 505 motion was left undecided for considerable time as there was some question about whether post-petition years would generate losses that could be carried back against tax debts, which would generate more money for creditors.  This became moot, so the Court stated it lacked jurisdiction; however, the taxpayer still wanted the determination to show tax losses, which he could then carryforward to future years (“establishing those losses will further his ‘fresh start’”).  The Court held that since the tax losses did not impact the estate it no longer a “matter arising under title 11, or [was] a matter arising in or related to a case under title 11”, which are required under the statutes.
  • The Tax Court in Best v. Comm’r has imposed $20,000 in excess litigation costs on an attorney representing clients in a CDP case. The Court, highlighting the difference in various courts regarding the level of conduct needed, held the attorney was “unreasonable and vexations” and multiplied the proceedings.  Because the appeal in this case could have gone to the Ninth Circuit or the DC Circuit, it looked to the more stringent “bad faith” requirements of the Ninth Circuit.  The predominate issue with the attorney Donald MacPherson’s conduct appears to have been the raising of stated frivolous positions repeatedly, which the Court found to be in bad faith.
  • And, Donald MacPherson calls himself the “Courtroom Commando”, and he is apparently willing to go to battle with the IRS, even when his position may not be great…and the Service and courts have told him his position was frivolous. Great tenacity, but also expensive.  In May v. Commissioner, the Tax Court sanctioned him another seven grand.
  • The Northern District of Ohio granted the government’s motion for summary judgement in WRK Rarities, LLC v. United States, where a successor entity to the taxpayer attempted to argue a wrongful levy under Section 7426 for the predecessor’s tax obligation. The Court found the successor was completely the alter ego of the predecessor, and therefore levy was appropriate, and dismissal on summary judgement was proper.
  • I’m not sure there is too much of importance in Costello v. Comm’r, but it is a mitigation case. Those don’t come up all that frequently.  The mitigation provisions are found in Sections 1311 to 1314 and allow relief from the statute of limitations on assessment (for the Service) and on refunds (for taxpayers) in certain specific situations defined in the Code.  This is a confusing area, made more confusing by case law that isn’t exactly uniformly applied.  The new chapter 5 of SaltzBook will have some heavily revised content in this area, and I should have a longer post soon touching on mitigation and demutualization in the near future.  In Costello, the IRS sought to assess tax in a closed year where refunds had been issued to a trustee and a beneficiary on the same income, resulting in no income tax being paid.  Section 1312(5) allows mitigation in this situation dealing with a trust and beneficiary.  There were two interesting aspects of this case, including whether the parties were sufficiently still related parties where the trust was subsequently wound down, and whether amending a return in response to an IRS audit was the taxpayer taking a position.
  • The First Circuit has joined all other Circuits in holding “that the taxpayer must comply with an IRS summons for documents he or she is required to keep under the [Bank Secrecy Act], where the IRS is investigating civilly the failure to pay taxes and the matter has not been referred for criminal prosecution,” and not allowing the taxpayer for invoking the Fifth Amendment. See US v. Chen. I can’t recall how many Circuit Courts have reviewed this matter, but it is at least five or six now.
  • The District Court for the District of Minnesota in McBrady v. United States has determined it lacks jurisdiction to review a refund claim for taxpayers who failed to timely file a refund request, and also had an interesting Flora holding regarding a credit carryback. The IRS never received the refund claim for 2009, which the taxpayer’s accountant and employee both testified was timely sent, but there was not USPS postmark or other proof of timely mailing, so Section 7502 requirements were not met.  Following an audit, income was shifted from 2009 to other years, including 2008.  This resulted in an outstanding liability that was not paid at the time the suit was filed, but the ’09 refund also generated credits that the taxpayer elected to apply to 2008.  The taxpayers also sought a refund for 2008, arguing the full payment of the ’09 tax that created the ’08 credit should be viewed as “full payment”, which they compared to the extended deadline for refunds when credits are carried back.  The Court did not find this persuasive, and stated full payment of the assessed amount of the ’08 tax was needed for the Court to have jurisdiction over the refund suite under Flora.  Sorry, couldn’t find a free link.
  • The IRS lost a motion for summary judgement regarding prior opportunity to dispute employment taxes related to a worker reclassification that occurred in prior proceeding. The case is called Hampton Software Development, LLC v. Commissioner, which is an interesting name for the entity because the LLC operated an apartment complex.  The IRS argued that during a preassessment conference determining the worker classification the taxpayer had the opportunity to dispute the liability, and was not now entitled to CDP review of the same.  The Court stated the conference was not the opportunity, as the worker classification determination notice is what would have triggered the right under Section 6330(c)(2)(B), and such notice was not received by the taxpayer (there was a material question about whether the taxpayer was dodging the notice, but that was a fact question to be resolved later).  The Hochman, Salkin blog has a good write up of this case, which can be found here.
  • The IRS has issued additional regulations under Section 6103 allowing disclosure of return information to the Census Bureau. This was requested so the Census could attempt to create more cost-efficient methods of conducting the census.  I don’t trust the “Census”.  Too much information, and it sounds really ominous.  That is definitely the group in Big Brother that will start rounding up undesirables, and now they have my mortgage info.
  • The Service has issued Chief Counsel Notice 2016-007, which provides internal guidance on how the results of TEFRA unified partnership audit and litigation procedures should be applied in CDP Tax Court cases. The notice provides a fair amount of guidance, and worth a review if you work in this area.
  • More bankruptcy. The US Bankruptcy Court for the Eastern District of Virginia has held that exemption rights under section 522 of the BR Code supersede the IRS offset rights under section 533 of the BR Code and Section 6402.  In In Re Copley, the Court directed the IRS to issue a refund to the estate after the IRS offset the refund with prepetition tax liabilities.  The setoff was not found to violate the automatic stay, but the court found the IRS could not continue to hold funds that the taxpayer has already indicated it was applying an exemption to in the proceeding.   There is a split among courts regarding the preservation of this setoff right for the IRS.  Keith wrote about the offset program generally and the TIGTA’s recent critical report of the same last week, which can be found here.



Another Flora Decision – Bad News for Tax Shelter Promoters Highlights Possible CDP Jurisdictional Issue

The Court of Federal Claims decision in Diversified Group, Inc. v. United States continues the recent focus on what it takes to get into the door with a refund suit.  (See recent posts on Flora rule here and here)  The Court bars the door to a tax shelter promoter seeking to pay only a fraction of the penalty imposed under IRC 6707 for failing to register a tax shelter scheme.  While feeling sorry for someone who promotes an egregious tax shelter scheme requires a great deal of effort, I think parties should have the opportunity to litigate the imposition of a tax or penalty without full payment.  The Court of Federal Claims decision rests on firm ground, yet barring someone against whom the IRS assesses a penalty, any penalty, from disputing that penalty in court without paying over $24 million seems inappropriate.  Maybe tax shelter promoters have access to that kind of money but most parties do not.

In this post I will explain the opinion but also connect the result with CDP and how the result in the trial court opinion possibly opens the door to litigating the merits of the penalty in a CDP proceeding.


Imposition of the Penalty

Diversified Group, Inc. (DGI), a boutique merchant banking firm, and its president created a Son of Boss type shelter which they marketed between 1999 and 2002 to 193 clients seeking to evade or avoid their income tax liabilities.  Around the Ides of March in 2002 the IRS notified DGI it was opening a 6707 penalty audit which later expanded to include the corporate president.  A short eleven years later in May, 2013, the IRS sent a notice of proposed adjustment to each promoter informing them that it had determined they each owed $42 million as a penalty for failure to register the tax shelter.  The promoters were given a chance to request a pre-assessment meeting with Appeals which they did not request.  They later received notice that the penalty was reduced to $24 million because of payments by others.  The penalty imposed resulted from “1 percent of the aggregate amount invested in [the] tax shelter” by their clients.  The IRS provided them with charts showing the investment by each of the 193 clients.

Attempt to Use Flora to Get into Court

The IRS assessed the penalty and sent notice and demand on February 21, 2014.  Shortly thereafter each promoter made a payment to the IRS reflecting 1% of the aggregate investment by one client.  (Note that the law on the computation of this penalty has changed since the year at issue though it would still produce a big number.)  DGI paid $15,450 and the president paid $18,310 plus interest.  With the payments, the promoters filed refund claims.  The IRS denied these claims on April 10, 2014, less than 45 days after the claims were filed, advising the promoters that the “penalty is not assessed on each individual transaction, but instead assessed based on the aggregate amount invested in the tax shelter, or the aggregate amount of fees paid to promoters of the tax shelter….  Thus, [the] penalties are non-divisible and must be paid in full before commencing a refund suit.”  The promoters filed suit three months later and the IRS immediately moved to dismiss the case.  The opinion addresses that motion and sustains it.

The fight here centers on the concept of divisibility.  The section 6707 penalty does not require the IRS to issue a notice of deficiency prior to assessment.  For liabilities the IRS can assess without issuing a notice of deficiency, litigation concerning the correctness of the penalties normally occurs in the district courts or in the Court of Federal Claims though I will discuss some other options below that become available in the collection process or in bankruptcy.  Under the Flora rule, the doors to the district courts or the Court of Federal Claims only open after a taxpayer fully pays the tax.  To mitigate the difficulty created by this jurisdictional barrier, many of the types of taxes not subject to the deficiency procedures allow the taxpayer to pay a divisible portion of the overall assessment and then sue.  The promoters sought to create a similar exception for the 6707 allowing them to pay only a portion of the penalty and get into court.

The Court of Federal Claims describes the promoter’s argument as “one that raises an issue of first impression, and that, if accepted, would carve out a new judicially created exception to the rule requiring full payment of the tax owed prior to filing suit in this court.”  In arguing for divisibility of the penalty as a path to refund jurisdiction, the promoters relied heavily on two cases, Noske v. United States and Humphrey v. United States.  Both of these cases dealt with the 6700 penalty for promoting abusive tax shelters and found that the penalty imposed by that section is divisible into each activity underlying the imposition of the penalty.  Because of the location in the Code of the 6700 and 6707 penalties as neighbors and the goals of the two penalties to stop tax shelters, the promoters here argued for the adoption of a similar rule of divisibility with respect to 6707.

The Court, accepting the argument of the IRS, explained that 6707 is a different type of penalty than 6700 because 6707 is based on one event – failing to list a tax shelter and not individual transactions of shelter promotion.  While the 6707 penalty gets calculated based on the amount of money going through the promotion, the penalty itself does not spring from individual transactions with investors but rather with the promotion as a whole.  Since the transaction sprang from the overall promotion and not from actions with respect to individual investors, the Court found that 6707 did not allow divisible payments.  In defining what makes a tax or penalty divisible the Court stated divisibility applies “when ‘it represents the aggregate of taxes due on multiple transactions.’  Stated otherwise, divisible ‘taxes or penalties….are seen as merely the sum of several independent assessments triggered by separate transactions.’”  The Court listed the specific taxes and penalties deemed divisible by judicially-created exceptions or by statute and found that 6707 is “not on the same footing as any of the taxpayers described in the exceptions set forth above.”

Other Routes to a Merit Determination – CDP

So, is there anything the promoters can do, short of full payment, to obtain judicial review of the IRS determination that they owe over $24 million in penalties?  What if they requested a CDP hearing following the filing of the inevitable notice of federal tax lien or a notice of intent to levy?  Does CDP provide a path to consideration of the merits unavailable through the divisible payment refund process?  It appears that they can litigate the merits of this penalty using the CDP process though the path to that answer may not be as clear as one might like and the answer appears to turn on whether the taxpayer has administratively requested penalty abatement after the assessment.

In Lewis v. Commissioner the Court held that the post-assessment opportunity to appeal the penalty determination administratively provides the taxpayer with all of the relief needed to prevent them from litigating the merits of the liability in a subsequent CDP hearing stating “Respondent argues that pursuant to section 6330(c)(2)(B) and section 301.6330-1(e)(3), QA-E2, Proceed. Admin. Regs., where a taxpayer has an opportunity for a conference with respondent’s Appeals Office before a collection action has begun, then the amount and existence of the underlying tax liability can neither be raised properly in a collection review hearing nor on appeal to this Court.”  The decision is based on an interpretation of Treas. Reg. §301-6330-1(e)(3), Q&A-E2.  Guest blogger Lavar Taylor wrote passionately on the incorrectness of the Court’s interpretation of the regulation.

Nonetheless, a question exists concerning the interpretation of the regulation as it relates to the timing of the trip to Appeals.  Lavar wrote about this and the trap for the unwary in his submission on behalf of the California State Bar entitled “Clarification of the Jurisdiction of the Tax Court to Decide the Merits of Tax Liabilities in Collection Due Process Cases and to Remand These Cases to the Office of Appeals.”  The regulation the Tax Court interpreted in Lewis provides: “An opportunity to dispute the underlying liability includes a prior opportunity for a conference with Appeals that was offered either before or after the assessment of the liability.  An opportunity for a conference with Appeals prior to the assessment of a tax subject to deficiency procedures is not a prior opportunity for this purpose.”

The taxpayer in Lewis sought abatement of the penalty after assessment.  The denial of the abatement request would have afforded him an opportunity to go to Appeals to discuss the denial.  That opportunity was a post-assessment opportunity of the type described in the first sentence of Q&A-E2.  When you make this type of appeal, no judicial remedy exists.

Lavar concludes that

the regulation is a trap for the unwary.  Taxpayers and unsophisticated representatives will generally be unaware that, by seeking an administrative review with the Office of Appeals of a penalty or other liability that can otherwise be challenged in a CDP appeal prior to submitting a CDP appeal, they are forfeiting their right to seek judicial review of the liability in the context of a CDP case.

Sophisticated taxpayers who wish to preserve their right to contest the liability in Tax Court in the context of a CDP case will simply refuse to submit a request for abatement of penalties prior to initiating a CDP appeal in response to the filing of a lien notice or the issuance of a notice of intent to levy.

The decision in Diversified Group states that the taxpayer chose not to go to Appeals to contest the penalty but that statement refers to a pre-assessment opportunity to go to Appeals.  The decision is silent on whether the taxpayer has sought penalty abatement post-assessment.  If not, it would appear that CDP would offer an opportunity to litigate this liability without first paying $24 million.

After Lewis a series of cases allow or discuss the ability to litigate the merits of a penalty in the CDP context.   Because these cases do not discuss Lewis, they do not parse the Q&A in the regulation.  It appears that either the IRS conceded jurisdiction because no post assessment request for abatement exits (although that is not clear from the cases) or the Lewis issue was simply overlooked.  The first case in this alternative line is Williams v. Commissioner where a taxpayer sought to litigate his liability for an FBAR penalty.  The Tax Court in dismissing the case for lack of jurisdiction because of the absence of a notice of deficiency or notice of determination also explored the CDP context.  The discussion of the taxpayer’s ability to get in the Tax Court’s door in the CDP context is dicta and does not appear to address an issue raised by the taxpayer.  The government did not raise the CDP issue.  Because the collection options available to the government with respect to the FBAR penalty do not include filing a notice of federal tax lien or making a levy, CDP would never be an option for contesting this type of penalty and the Court went through the analysis to show that its doors were barred in the case before it and would always be shut to a determination on the merits of this type of penalty.

Next, a district court decision, harking back to the days when CDP cases could be heard in district court or Tax Court depending on the type of tax at issue, also addressed the issue in dicta.  In D&M Painting, Corp. v. United States, the court indicated that taxpayers seeking an injunction to stop the IRS from collecting on an IRC 6707A penalty could not enjoin the IRS from collecting, in part, because they had the right to dispute the liability without paying first in a CDP hearing.  The district court in D&M did not cite to Treas. Reg. §301-6330-1(e)(3), Q&A-E2.

Later that same year D&M is decided, the Tax Court looks at the possibility of CDP jurisdiction in another 6707A case.  (There is a difference in the penalty between 6707 and 6707A; however, I cannot see how that difference would matter in the analysis here.)  In Smith v. Commissioner, another regular T.C. opinion, the Tax Court says it does not have jurisdiction over 6707A cases in a deficiency proceeding similar to its finding in Williams regarding the FBAR penalty but, in dicta, states “we would presumably have jurisdiction to redetermine a liability challenge asserted by petitioners in a collection due process hearing.” The Court cites to Williams and to D&M.  Again, no mention is made of the Lewis opinion or of the regulation and there is no indication, without going back and reading the documents filed by Chief Counsel’s office, that it agreed with or conceded this issue.

Yari v. Commissioner is another regular T.C. opinion in which the taxpayer seeks to contest the penalty in a CDP case.  Taxpayer seeks to litigate the underlying 6707A penalty.  The case was submitted fully stipulated and on the merits presented the issue of how to calculate the 6707A penalty.  The Court states “the parties assume we have jurisdiction over the penalty issue in this case.  But the Court has an independent obligation to determine whether it has jurisdiction.”  So, Chief Counsel’s office did not raise the Lewis issue leading to the conclusion that no post-assessment abatement request occurred.  The Court goes through an analysis concerning its jurisdiction citing to the Williams case and concluding that “Petitioner has not had an opportunity to dispute the amount of the penalty, and, consequently, we have jurisdiction to redetermine the amount of the penalty.”  The Court cited to IRC 6330(c)(2)(B) but not to the underlying regulation.  The use of the word opportunity raises the question of whether the taxpayer would always have the opportunity to make a post-assessment penalty abatement request and to appeal a denial and how that opportunity would color any decision.

Finally, in Gardner v. Commissioner `decided in August, 2015, the Court in a 6700 penalty case brought under the CDP provisions accepts the concession of Chief Counsel’s office that petitioner did not have a prior opportunity to contest the liability.  What makes this case different from the other post Lewis cases is that the Appeals Officer during the CDP hearing “declined to discuss the underlying liability, stating that Mr. Gardner had had a prior opportunity to dispute it but he had not done so and therefore was not permitted to raise the issue at the section 6330 hearing.”  One presumes from the concession by Counsel that the Appeals Officer may have misread the regulation and its application in Lewis to the facts of this case.

The IRS has not abandoned Lewis despite Lavar’s plea to them.  Lewis and the regulation make it unclear without more information whether the promoters here may be able to get into court to contest the penalties through the CDP process since their post-assessment activity regarding penalty abatement is unknown.

Another Route to Merits Determination – Bankruptcy

Assuming the promoters cannot get into Tax Court through the CDP process, one final chance at a judicial hearing on the merits of the penalty exists.  I do not know the financial circumstances of the promoters.  Bankruptcy offers a possible avenue to litigate the liability without paying; however, it comes with potentially high costs in other respects.  Section 505(a) of the Bankruptcy Code permits debtors to litigate the merits of their tax liability either in pre or post-assessment status.  If one or both of the promoters files bankruptcy, the possibility of a judicial review of the penalty prior to paying it exists.


As I mentioned at the outset, the requirement that a taxpayer pay $24 million in order to obtain judicial review of an IRS penalty determination without going into bankruptcy seems wrong.  Yet, I agree with the reasoning of the Federal Circuit concerning the divisibility of the 6707 penalty under the Flora analysis.  I agree with Lavar that the CDP regulation should change and the result in Lewis should change to allow for determinations on the merits of the penalty whenever the person upon whom the penalty is imposed has no opportunity for judicial review without full payment.  Another fix is to rethink Flora.  Maybe it’s time to retool the way taxpayers get into court.

Tenth Circuit Hook Opinion: Interest and Penalties Must Also Be Paid to Satisfy Flora Full Payment Rule

We welcome back frequent guest blogger Carl Smith writing today on a surprising issue.  The surprise could be that the Flora rule still has open questions at this stage of life or that the circuit court opinion deciding the issue came out as unpublished and non-precedential.  Either way, this is an important development that bears watching.  Keith

This is just a brief update to part of a post that I did on February 4, 2015.  In that post, I noted that Flora v. United States, 362 U.S. 145 (1960), held that for a court to have jurisdiction of a tax refund suit, the taxpayer must, before bringing suit, fully pay the tax as billed by the IRS.  In a footnote in Flora – one that was arguably dicta – the Supreme Court wrote that “the statute lends itself to a construction which would permit suit for the tax after full payment thereof without payment of the interest”. Id., at 170 n.37. You would think that over the half century since Flora was decided, the Circuit courts would have resolved the question of whether the Flora rule requires full payment of interest and penalties, as well, but the issue has only been discussed (prior to last week) in two conflicting appellate court opinions. This post is to report that the Tenth Circuit just weighed in on this question in Hook v. United States, 2015 TNT 161-11 (10th Cir. Aug. 19, 20-15), an unpublished, non-precedential opinion.


In Magnone v. United States, 902 F.2d 192 (2d Cir. 1990), the Second Circuit wrote that “the full payment rule requires as a prerequisite for federal court jurisdiction over a tax refund suit, that the taxpayer make full payment of the assessment, including penalties and interest”.  Id., at 193. Several years later, without noting Magnone, the Federal Circuit in Shore v. United States, 9 F.3d 1524, 1527-28 (Fed. Cir. 1993), expressed a different view, citing the Flora footnote and holding that payment of the tax alone was sufficient to commence a refund suit, so long as the taxpayer was not making any argument specific to interest (such as its being wrongly computed) or penalties (reasonable cause).  The court wrote that “only if the taxpayers assert a claim over assessed interest or penalties on ground not fully determined by the claim for recovery of the principal must they prepay such interest and penalties as well as the assessed tax principal.”  Id.

I find the Shore caveat as to when interest and penalties must be paid a bit odd and hard to read out from the statute. But, in a Cardozo Tax Clinic case where the taxpayer made no independent arguments about penalties and interest, I took advantage of the Shore holding to go to district court after only having paid the tax – i.e., sooner than I might have under Magnone. I couldn’t wait for the taxpayer to pay the roughly $2,000 in interest and late-payment penalties because she was then retired, and I had no idea if she would ever have the money to pay the interest and penalties that she currently couldn’t afford to pay. In response, the DOJ made no objection to jurisdiction, since the IRS agrees with the taxpayer-friendly Federal Circuit Shore interpretation. However, the government reserves the right to continue to pursue collection of the unpaid interest or penalties either by way of levy or counterclaim in the suit.  1996 FSA LEXIS 476 (Mar. 15, 1996). If the EDNY district court judge sua sponte had raised a jurisdictional objection in my case, citing Magnone, I was prepared to first try to distinguish Magnone, but if necessary go to the Supreme Court, citing the Court’s footnote in Flora and a Circuit split on this issue. In any event, in short order, the government conceded that my client was due a full refund of what she had paid, and the judge never brought up the possible jurisdictional objection to my suit.

In Hook, the taxpayers were lawyers (married to each other) who were extremely litigious over their back taxes. They brought suit in district court raising various grounds for relief. Among the grounds was that the court had jurisdiction of their suit as a tax refund suit under 28 U.S.C. § 1346(a)(1). They alleged that they satisfied the full payment rule for all tax years. But, the district court disagreed. The Tenth Circuit affirmed, writing that Ms. Hook’s

contention that the amended complaint shows all amounts were paid, including interest and penalties, is conclusory. And she fails to identify any error in the district court’s determination that Ms. Tibbs’s declaration and supporting exhibits established that the accounting in the amended complaint was faulty in omitting substantial statutory interest and penalties, both of which are treated as taxes under the Internal Revenue Code. See 26 U.S.C. section 6601(e)(1) (interest is treated “in same manner as taxes” for assessment and collection purposes); id. section 6671 (same with respect to penalties); Magnone, 902 F.2d at 193 (same with respect to interest and penalties).

The Tenth Circuit had previously cited the above-quoted sentence from Magnone providing that full payment included paying all interest and penalties.  The Tenth Circuit opinion does not mention Shore or the footnote in Flora seemingly contradicting the Tenth Circuit’s holding.

I checked the briefs in the Tenth Circuit, and none cites or discusses Magnone, Shore, or the footnote in Flora.  The district court did a better job – citing Magnone, but worrying about the footnote in Flora.  The district court wrote:  “The Court recognizes that under Flora, 362 U.S. at 170 n.37, an issue may be raised as to whether the payment of interest is also required. As Plaintiffs are challenging not only the tax but also the interest and ‘penalties/additions to tax,’ without further explanation as to the bases, the Court finds the full payment rule requires payment of all amounts challenged.”  (Slip op. at 14 n.11)

Personally, I think this is a pretty weak footnote, and the courts (both the district court and Tenth Circuit) should have discussed Shore when citing Magnone, as there was no Tenth Circuit precedent on the issue.

Somehow, because of all the other problems in the case, I doubt the Supreme Court will grant cert. on this jurisdictional issue if this very litigious couple seeks cert. after discovering the Shore opinion.  This case is just too messy on the facts.  And, as far as I can see, it really has no chance of success on the merits, even if the court had jurisdiction.

Considering how long this Circuit split over Flora has been in existence, I think it high time for Congress to step in and clarify it legislatively, and adopt the Shore rule.  But, I prefer even a broader carve-out of the Flora rule from § 1346(a)(1).  See my article “Let the Poor Sue for a Refund Without Full Payment”, 125 Tax Notes 131 (Oct. 5, 2009).

Can One Meet the Flora Full Payment Rule After the Unpaid Balance Was Written Off?

Carl Smith explores a recent 11th Circuit refund case and discusses some of the nooks and crannies of the Flora full payment rule, such as the intersection of the lapsing of the statute of limitations on collection and the refund claim statute of limitations. Les

In Lawrence v United States, a per curiam Eleventh Circuit recently dismissed a taxpayer’s second amended compliant and wouldn’t let him try a third amendment. His original complaint was a scattershot, kitchen sink affair lasting 101 pages.  His first amended complaint was worse — 128 pages.  After the district court then ordered him to file a second amended complaint of no longer than 20 pages, he filed one consisting of 26 pages, but attaching scads of exhibits.  Although he again offered to amend his complaint a third time, as this point, the district court dismissed the complaint for lack of jurisdiction.  In addition to the complaint’s being an incomprehensible mess, the court noted that there were no detailed allegations of or evidence that he had actually filed administrative refund claims for any of the years involved (as required by section 7422(a)), and for some years, there was also evidence that he had not fully paid the balances due shown on IRS transcripts.  Flora v. United States, 362 U.S. 145 (1960) (opinion on rehearing) — cited by the court — certainly interpreted the jurisdictional statute of 28 U.S.C. § 1346(a)(1) to require full payment before a district court tax refund suit is brought.  But this case presents a couple significant issues, neither of which are answered:  Can one ever meet the Flora full-payment requirement after the section 6502 statute of limitation on collection has lapsed and the balance was written off?  And was the court looking at the right amount that Mr. Lawrence had been required to pay before Flora was satisfied — i.e., did he need to pay the tax, penalty, and interest, or only the tax?


Turning to the first question, imagine that an income tax module for one year shows a balance due, despite some payments having been made.  Then, imagine that the year is so old that the collection period under section 6502 expires, and the IRS writes off the balance with a credit entry to zero out the account.  Would it be possible for a taxpayer at some much later date to send a check to the IRS for the balance that was written off and direct the check in payment of the year for which the IRS no longer maintains a module?  And what should the payment amount be to meet the Flora rule, since, no doubt, when the IRS wrote off the balance, some time had passed since the IRS had posted additional late-payment penalties and interest to the account, so an account write-off might be far less that the amount of tax, interest, and penalties that would have been due had the IRS first assessed the accrued items before placing a credit entry to zero out the account?  Third, what about the additional interest that in theory might have accrued on the written off balance?  The IRS is not authorized to assess interest after the collection period has expired.  Sec. 6601(g) (“Interest prescribed under this section on any tax may be assessed and collected at any time during the period within which the tax to which such interest relates may be collected.”)   Fourth, what of the provision at section 6401(a) that reads, “The term ‘overpayment’ includes that part of the amount of the payment of any internal revenue tax which is assessed or collected after the expiration of the period of limitations properly applicable thereto”?

Take this example:

For her 2003 year income taxes, the taxpayer timely filed an income tax return on April 15, 2004 showing a balance due of $10,000, which was immediately assessed.  Over the years, the taxpayer sends another $8,000 to the IRS — with the last $1,000 being paid on April 1, 2014. The account on that date shows about $4,000 still due — consisting of $1,000 of tax and the rest interest and late-payment penalties that were last assessed in 2006.  On April 15, 2014, the IRS writes off the $4,000 balance without first posting (i.e., assessing) the accrued interest and penalties.  Had it posted the additional interest and penalties through April 14, 2014, the balance would have been $7,000.  Imagine that on June 1, 2015, the taxpayer decides to fully pay off the tax and file a refund claim based on her erroneous inclusion in income of what she now contends was a non-taxable return of capital.  Let’s say she pays the $4,000 amount that the IRS actually placed as a credit in her account to zero it out, and she files an administrative refund claim for $5,000 — consisting of the $4,000 she just paid, which is treated as an overpayment under 6401(a), and the $1,000 payment made on April 1, 2014, less than two years before the claim was filed under the rule of 6511(a).  Is there anything to stop this?  Should she have also been required to pay the additional $3,000 of interest and penalties that accrued but were not posted before the write-off?  Should she pay any more, since she is getting an interest-free loan from the IRS after April 15, 2014, since the IRS at that point cannot by law imposed any more interest?

Frankly, this leaves me scratching my head.  If any reader can point me to case authority on this, I’d like to hear.  I never ran across it before in my practice. Since there is no mention in the Lawrence Circuit court opinion that the taxpayer there made any payments after the section 6502 statute expired, nothing in Lawrence answers these questions.  Indeed, all the Lawrence opinions says of the facts of payment is, “Despite Lawrence’s allegations that he fully paid the assessed amounts for every disputed tax year, the documents attached to the second amended complaint and the motion to dismiss show that, for every year other than the tax years 1980, 1991, and 1992, Lawrence had an unpaid balance that was written off by the IRS as uncollectible”.

This sentence from Lawrence triggered another issue to my thinking:  Why did the court refer to “balance due”?  We tax lawyers know that the balance due on an IRS transcript consists of assessed taxes, interest, and penalties.  I think the court should have examined whether Mr. Lawrence had paid the full tax, even if he did not pay the full interest and penalties.  This brings up an issue that I find few tax controversy lawyers are aware of:  In Flora, in the same footnote 37 at 362 U.S. 171 that notes that it may be appropriate to treat excise taxes as divisible — a hallmark of 6672 litigation since Flora — there is another sentence that reads that “the statute lends itself to a construction which would permit suit for the tax after full payment thereof without payment of the interest”.   Thus, if Mr. Lawrence had paid the tax in any year, but not any of the interest and penalties, perhaps he might have gotten some recovery if he had filed administrative claims and sought tax payments made in the prior two years.

Lower courts tend not to discuss this tax-only sentence from Flora, but I have used it to advantage in my practice.  For example, I once filed a refund suit in the EDNY after the IRS had snatched a 2002 EITC refund and applied it to a 1998 liability that the taxpayer thought improperly denied her dependency exemptions.  The snatched amount fully paid the 1998 tax deficiency (which the taxpayer had failed to contest, since she had moved and never got the notice of deficiency) — but hardly any of the interest and penalties.  She was presently unemployed and in currently not collectible status, so my low-income client was in no position to pay all the accrued interest and penalties totaling over $2,000 before bringing a suit with respect to 1998.

I had a discussion with the DOJ attorney before he filed either a motion to dismiss or an answer to my complaint, and he agreed that the payment of the tax alone in her case was jurisdictionally sufficient under Flora and a Federal Circuit case, Shore v. United States, 9 F.3d 1524, 1527-1528 (Fed. Cir. 1993), which relied on the Flora footnote.  In Shore, the Federal Circuit held that payment of the tax alone was sufficient, so long as the taxpayer was not making any argument specific to interest (such as it being wrongly computed) or penalties (reasonable cause).  The court wrote that “only if the taxpayers assert a claim over assessed interest or penalties on ground not fully determined by the claim for recovery of the principal must they prepay such interest and penalties as well as the assessed tax principal.”  Id. I find this a very peculiar ruling, but won’t look a gift horse in the mouth. Although technically, it is the courts who on their own determine their jurisdiction — not parties like the IRS or DOJ — the IRS has announced that it follows the Shore rule, though the government reserves the right to continue to pursue collection of the unpaid balance either by way of levy or counterclaim in the suit. 1996 FSA LEXIS 476 (Mar. 15, 1996). In my case, the DOJ conceded the suit shortly after I filed it, and neither the judge nor magistrate were made aware of or expressed themselves independently on the Flora issue.  That was a good thing, since I was unable to find any other Circuit opinion that discussed the Shore rule, but the Second Circuit — before Shore — had held that Flora requires the full payment of all tax, penalties, and interest.  In Magnone v. United States, 902 F.2d 192 (2d Cir. 1990), the Second Circuit wrote that “the full payment rule requires as a prerequisite for federal court jurisdiction over a tax refund suit, that the taxpayer make full payment of the assessment, including penalties and interest”.  Id., at 193.  If Magnone had been raised by the district court, I was prepared to take the issue to the Second Circuit.  Although I could not distinguish the devastating Magnone language, I could distinguish the context.  In Magnone, the taxpayers had already paid all the tax.  They then paid part of the interest.  In their suit, they did not challenge the tax assessed, but challenged whether interest suspension had been properly done under section 6601(c) and whether it was right that they be charged old section 6621(c) tax motivated interest.  Since these are challenges “not fully determined by the claim for recovery of the principal”, the ultimate ruling in Magnone is consistent with Shore, though on different reasoning.

Has anyone else had a Flora case like mine where they paid all the tax, but not the interest and penalties?  I keep waiting to hear of a ruling from another Circuit.  Doubtless it will be an unusual ruling because the DOJ won’t itself raise the issue.  But, you can’t stop a court from sua sponte raising a jurisdictional issue.

Anyway, it is amazing how many little and not so little issues were possibly presented in the Lawrence case that the court apparently knew little about.

A Proposal to Amend Flora or Collection Due Process for Individuals Examined by Correspondence Who Do Not Pick Up or Process Their Mail

I recently wrote about the Tax Court’s decision in Onyango v. Commissioner, 142 T.C. No. 24 (2014) in which the Court held that an individual who received the certified mail notification that would/should have led that individual to go to the post office and pick up the notice of deficiency had, for purposes of I.R.C. 6330(c)(2)(B), received the notice of deficiency. Instead of timely going to the post office, the individual made no effort, or no timely effort, to go to the post office to pick up the notice and the Court, properly in my view, determined that this failure precluded the individual from contesting the merits of his tax liability through the CDP statute even though he never “had” the opportunity to do so prior to the assessment. 

Because this individual’s behavior mirrors the behavior of many clients who come to my clinic and who come to clinics around the country, I want to talk about the current system and how it could change to address the situation created by fairly large class of individuals who do not either pick up, open or deal with their mail. As someone who has previously confessed to having some misgivings about CDP, my suggestion here may be too radical and may foster behavior we want to discourage but the current system fails many individuals. If we really want CDP to work, it may be worth examining taxpayer behaviors matched against statutory requirements. 


The traditional system of tax assessment, as it has morphed over the past three to four decades, does not work for a large class of citizens. With the advent of correspondence examination (Corr Exam) and automated collection sites (ACS) in the 1980s, the IRS makes no personal touch on a segment of the population most in need of a personal touch in order to understand their rights. 

Instead, we have created a system that sends correspondence to the least competent taxpayers rather than giving them an individual in their community assigned to their case. So, the current system of examining the poorest individuals consists of sending 2-3 letters, which a high percentage of individuals ignore or misplace and then granting the IRS permission through the statute to assess an additional tax liability. We follow up the first letter writing campaign, which was so successful, with another one, consisting of 3-4 letters before the statute gives the IRS the right to levy. 

The IRS levies and takes the taxpayer’s wages or bank account or social security payments. It now has the attention of the taxpayer who now has almost no statutory rights to contest either the liability or the collection process. It is too late to go to Tax Court either to contest the underlying merits of the assessment or to use the CDP process. Just when these taxpayers are ready to address their problem, they have a limited, almost entirely administrative path remaining. The nicely paved road to Tax Court has given way to a goat path up the hill to administrative relief. 

To its credit, the IRS did not even need to create the goat path but it does make it possible for the taxpayer to address the merits through audit reconsideration, the collection through an equivalent hearing or a CAP appeal or an offer in compromise based on doubt as to liability. Still, the taxpayer has lost all rights to go to court should the administrative path prove unsuccessful. The inventories of low income taxpayer clinics are filled with these taxpayers because the impersonal Corr Exam and ACS process to which low income people are assigned does not meet their needs. 

Perhaps we say they get what they deserve because they are making the decision to ignore their mail. We might say that we tried in 1998 by creating CDP to take care of the problem created by the 1980s development of Corr Exam and ACS. I think there is another way to look at the situation. 

When the current procedures for tax administration were built, the rich or upper middle class were the ones interfacing with the tax system. The refund process served as the relief valve everyone thought existed when a bad assessment occurred. The Flora rule, which goes back to ancient times before Corr Exam and ACS, effectively bars low income taxpayers, as well as many others, from using the Courts through the refund process to redress a bad assessment (See Flora v. U.S., 362 U.S. 145 (1960) (holding that a taxpayer generally must pay the full amount of income tax deficiency assessed by IRS before he or she may challenge its correctness by suit in federal district court or Court of Federal Claims for refund under 28 U.S.C. § 1346(a)(1)); see also 26 U.S.C. § 7422 (requiring taxpayers to file claim with IRS prior to commencing refund suit)). The less friendly confines of the District Court compared to the Tax Court also makes the refund route an uphill procedural battle for the unrepresented or poorly represented taxpayer. 

The creation of the CDP remedy and the potential relief valve of tax merits litigation during the collection period, may have seemed like an idea that would provide relief to many who missed the initial opportunity to contest the tax – for whatever reason, but for most taxpayers the CDP opportunity which wraps the notice of intent to levy in a package that can result in litigation on the collection activity if not the underlying merits, comes in yet another envelope, usually number 7 or 8, that the taxpayer will toss or set aside not knowing or understanding the importance of their actions. 

The decision in Onyango v. Commissioner and a recent post on the low income taxpayer listserv (published at the end of this post) by a relatively new tax clinician struggling through the possibilities for remedial action made me think about the problem and possible solutions. For a client who has squandered the statutory opportunities for merits relief something other than the illusive opportunity for such relief through CDP needs to happen. The necessary relief should provide a meaningful opportunity for a group of taxpayers, by and large but not exclusively low income, who are now a part of the tax procedure system which developed its procedures before they joined the party. 

What might be done to rethink how this group of individuals who did not participate in the tax system when the procedures developed and who only get examination or collection contacts from a unit of IRS employees but never receive an individual case assignment? My first facetious thought was to just levy first. If you go ahead and take their money at the front you have their attention. Then give them rights instead of waiting until all of their statutory rights are gone, as a result of correspondence, before taking their money and getting their attention. While this idea is relatively simple in concept, I cannot put it forward with any sense that it represents the right thing to do. 

Instead, we might rethink Flora or rethink CDP. 

Suppose we were building the refund rule at a time when the highest number of examinations, by a long shot, were done by Corr Exam and most of the people ending up with tax liabilities had no ability to fully pay the taxes. Would we have ended up with the Flora rule? Would the Supreme Court have required the low income taxpayers now caught up in the tax system because we have decided to use the tax system to deliver social benefits to fully pay the tax in order to get into court? I do not think it would. I think the Flora decision reflects the times. At that time people who chose not to go to Tax Court generally were middle class or upper class citizens or entities that missed the Tax Court without the systemic impediments facing low income taxpayers. Once they missed the Tax Court, they generally, but not always, had the means to go after the liability by paying and suing in district court. 

What if we changed Flora or changed 6330(c)(2)(B) to allow a taxpayer to raise the merits of the underlying liability in Tax Court after a levy had occurred if the taxpayer was examined by Corr Exam instead of by an individual examiner assigned specifically to their case? If the change occurred by revoking Flora in Corr Exam cases, taxpayers could file a claim for refund after the collection of any amount of the taxes assessed as a result of the Corr Exam and not just after full payment. Such a change would acknowledge that examining taxpayers through correspondence often fails to meaningfully engage them in the process and allowing them to go through the full refund claim process, including the opportunity to go to Court if agreement were not reached, provides on the back end the full consideration of their case that Corr Exam does not offer. I would also open the doors to Tax Court in this type of litigation because the Tax Court has developed that type of procedures and culture that works better for low income taxpayers than the current procedures in District Court. 

Alternatively, and less satisfactorily in my view, CDP could change to allow taxpayers to address the merits in the CDP process if they did not receive the notice using the current test or if they were examined by Corr Exam. This option still limits relief to those who open and process their incoming mail and does not address my concern that many taxpayers do not react to mail but react to a taking of their property. The merits litigation, if allowed, would follow the traditional rules. The Tax Court would examine that aspect of the CDP determination consistent with its deficiency jurisdiction, i.e., de novo. The taxpayer would have the burden of raising the amount or existence of the liability in the request for CDP relief. I note that CDP cases could initially go to either Tax Court or District Court but now go exclusively to Tax Court which I think is a good result. 

I doubt that either of the changes I am proposing would result in a massive opening of litigation on the merits of taxes but it would have the effect of saying to a group of people who were not around when the current tax procedures were developed that we value them. We want to give them an opportunity to contest their liability in a court proceeding if it cannot be resolved administratively and even though we, as a government, do not have the resources to examine their returns individually rather than on a group basis, we still want them to have every opportunity to contest the liability if they feel they do not owe it. 

CDP sought to relieve the pressure created by Corr exam and ACS. I think it has provided some relief but fails in the area of underlying merits for the reasons identified by the Tax Court in its recent opinion. The IRS seeks to relieve the pressure through its creation of the audit reconsideration process but without the opportunity for court that does not offer full relief when administrative resolution fails. The tax procedure system needs to adapt to the inclusion in the process of a group of individuals not contemplated when it was built. We can say that those individuals need to adapt to the system but that ignores reality. Making a change will cost very little compared to the fairness it would provide. 

Here is the recent post on the low income taxpayer listserv that highlights the dilemma clinicians representing low income taxpayers regularly face: 

For some reason, although 26 USC 6330(c)(2)(b) and the instructions to a CDP request form state that you can’t raise the underlying liability in a CDP hearing if the taxpayer had received the Statutory Notice of Deficiency, I had been thinking that the taxpayer could still submit an Offer In Compromise based upon doubt as to liability in the CDP context. 

Upon further reflection and reading of the Internal Revenue Manual, I now think that if I submit an OIC-DATL in this situation it is just going to get rejected. 

But, I would still like to challenge the underlying liability.  

It strikes me that the options are either (a) withdraw the CDP and file the OIC-DATL outside of the CDP context, or (b) to file a Request for Audit Reconsideration, which as I understand it would also be separate and apart from the CDP process, and not entitled to any judicial review – if we went this route, client would lose the CDP opportunity, and then if the Audit Reconsideration was rejected, client wouldn’t have recourse to CDP and attendant judicial review 

Alternatively, even though it doesn’t directly attack the underlying liability, could we file an OIC-ETA based upon Public Policy/Equity (assuming that the debt will be determined collectible or not otherwise addressable as an ETA Hardship), which could be done in the CDP hearing context and which would be subject to judicial review if rejected? 

Does anyone have any thoughts about whether it would be better to pursue the Audit Reconsideration/OIC-DATL and forgo the CDP opportunity, or to pursue an OIC-ETA Public Policy/Equity in the CDP context?