What Happens After Boechler – Part 3:  The IRS Argues that IRC 7459 Requires that IRC 6213(a) Treat the Time for Filing a Tax Court Petition as Jurisdictional

After Congress created the predecessor statute to IRC 6213 in 1924 (and created the Board of Tax Appeals – the predecessor to the Tax Court) it came back in 1926 and 1928 to create a separate statute which is now IRC 7459.  Section 7459 provides that a dismissal from a Tax Court case on jurisdictional grounds does not prevent the taxpayer from paying the tax and suing for refund.

When Carl Smith and I began making the argument that time periods for filing a Tax Court petition are not jurisdictional time periods, we initially confined our arguments to Collection Due Process (CDP) and innocent spouse cases out of concern that succeeding in deficiency cases might harm taxpayers because of 7459.  As we thought about this further over time, we could not remember a single incidence of a taxpayer being dismissed from the Tax Court on jurisdictional grounds and subsequently full paying the tax and suing for refund.  Of course, this does not mean it has never happened, but it does suggest it happens rarely.

This post will explain why IRC 7459 should not factor into the decision of whether IRC 6213 is a jurisdictional provision or a claims processing rule.  That conclusion results from both the language of the two statutes as well as the goal to protect taxpayers.

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In the prior two posts we have explained why the Supreme Court’s decision in Boechler knocks out all of the arguments that IRC 6213 is a jurisdictional provision previously made by the IRS, the Tax Court, and other courts, including the 9th Circuit in Organic Cannabis.  This post looks at the arguments regarding IRC 7459 and the cases the Tax Court dismisses in order to provide an explanation for removing the last argument from consideration.

In Organic Cannabis the 9th Circuit explained the various types of suits a taxpayer could bring to contest a tax liability and pointed out that:

if the taxpayer does file a petition in the Tax Court, then a decision “dismissing the proceeding shall be considered as its decision that the deficiency is the amount determined by the [IRS],” id. § 7459(d), and such decision as to “amount” is entitled to preclusive effect in subsequent proceedings between the taxpayer and the IRS, see Malat v. Commissioner, 302 F.2d 700, 706 (9th Cir. 1962). [emphasis added]

We have written before about the effect of a Tax Court dismissal, and we have explained that petitioners to the Tax Court cannot voluntarily dismiss a Tax Court case once jurisdiction has attached.  After setting up the general rule, the 9th Circuit went on to explain the exception in IRC 7459(d) when the Tax Court dismisses a case because it lacks jurisdiction:

there is no such “decision” as to “amount,” and no preclusive effect, if the Tax Court’s “dismissal is for lack of jurisdiction.” 26 U.S.C. § 7459(d) (emphasis added)

Then the 9th Circuit used as one of its bases for finding IRC 6213 to be a jurisdictional provision with regard to the time of filing the problem that would attach if it were not jurisdictional:

Under Appellants’ non-jurisdictional reading of § 6213(a), the Tax Court’s dismissal of a petition as untimely could potentially have the perverse effect of barring the taxpayer from later challenging the amount in a refund suit—ironically yielding precisely the sort of “harsh consequence[]” that the Supreme Court’s recent “jurisdictional” jurisprudence has sought to avoid.  Kwai Fun Wong, 575 U.S. at 409.  That peculiar outcome is avoided if § 6213(a) is read as being jurisdictional, because then dismissals for failure to meet its timing requirement would fall within § 7459(d)’s safe-harbor denying preclusive effect to Tax Court dismissals “for lack of jurisdiction.” 

So, the 9th Circuit used what it thought would be a negative effect of finding IRC 6213 to be a claims processing rule as a basis for justifying its decision.  This is wrong both as statutory interpretation and wrong in thinking that keeping IRC 6213 as a jurisdictional provision would not harm taxpayers, while making that deadline non-jurisdictional would harm taxpayers.

With respect to statutory interpretation, IRC 7459 simply has no role to play.  The argument for the role of IRC 7459(d), at least based on the IRS argument, is that interpreting the jurisdictional dismissal exception of that subsection to exclude dismissals for late filing would render the exception superfluous.  The IRS has argued that the only dismissals that are currently jurisdictional (other than those when no notice of deficiency was issued and so the amount of a deficiency cannot be set out in the dismissal order) are from late filing. This argument fails because many reasons exist why a petition may be dismissed for lack of jurisdiction other than merely late filing or the lack of a notice of deficiency.  The most obvious situation occurs when the Tax Court dismisses a petition for lack of jurisdiction due to an invalid notice of deficiency because the IRS did not send the notice to the taxpayer’s last known address.  See, e.g., Crum v. Commissioner, 635 F.2d 895 (D.C. Cir. 1980).  Another example occurs when the automatic stay in bankruptcy bars the filing of a Tax Court petition, see, e.g., Halpern v. Commissioner, 96 T.C. 895 (1991).  Another example occurs when a corporation lacks capacity to file the petition, see, e.g., Vahlco Corp. v. Commissioner, 97 T.C. 428 (1991) (Texas law).  The biggest reason for dismissal from Tax Court for lack of jurisdiction occurs for failure to pay the filing fee – almost 2/3rds of the dismissals occur for this reason.  So, the IRS is wrong when it argues that determining IRC 6213 is a claims processing rule renders IRC 7459(d) superfluous.

The legislative history of IRC 7459(d) also does not support the conclusion that Congress enacted the statute to preserve the rights of taxpayers who file late in the Tax Court to avoid res judicata in a subsequent refund suit involving the same deficiency.  There is no such legislative history.  There is also nothing in the language of IRC 7459 that speaks to the time frame for filing a Tax Court petition as a jurisdictional time frame.  There is simply no language to parse.

After you leave the legal arguments that have no merit, you move to the apparent presumption by the 9th Circuit that somehow IRC 7459 helped taxpayers.  First, there’s the problem that Congress gave no indication it sought that result, either in the language of the statute or its legislative history. Second, the actual effect of the 9th Circuit’s take on the statute hurts far more taxpayers than it helps.

Carl Smith looked at the dismissals for lack of jurisdiction due to late filing in February and March of 2022 searching DAWSON using the search words “lack of jurisdiction and timely.”  He found 103 cases which suggests 618 dismissals over the entire year or some similar number.  Each of those individuals could theoretically be adversely impacted if section 7459(d)’s exception for jurisdictional dismissal could not apply, so that res judicata would prohibit their filing later refund suits.

To know how the loss of 7459(d) protection could adversely impact this group, it’s necessary to know how many taxpayers in this group paid the tax and filed a suit for refund.  For this fiscal year ending September 30, 2020, 188 refund suits in total were brought in the Court of Federal Claims and the district courts.  Not all of the 188 complainants filed after a prior Tax Court dismissal for late filing and perhaps none of them did.  Indeed, Carl looked at all district court and CFC opinions issued in 2021 using the search terms “refund and (Tax Court) and dismiss!” and could not find a single refund suit in which it was clear that the IRS had issued a notice of deficiency, the taxpayer had then late-filed a Tax Court suit, and, after the suit’s dismissal, the taxpayer sued for a refund. 

Carl did come across one 2021 opinion where a taxpayer’s Tax Court deficiency suit had been dismissed for lack of jurisdiction, purportedly for late filing, and a CFC refund suit ensued — see my post of June 4, 2021 on the case, Jolly.  However, in that case, it was unclear whether the IRS had ever issued a notice of deficiency, with the IRS arguing in the Tax Court that a notice of deficiency had been issued, but arguing in the CFC that the IRS had never issued one and that the Tax Court dismissal was wrong for saying there had been a late-filed petition rather than a petition lacking an underlying notice of deficiency.  And, in Jolly, the taxpayer did not fully pay the tax before bringing the CFC suit.    Reading the 2021 opinions, Carl also found a citation to a pre-2021 opinion in a refund suit where a taxpayer brought a CFC suit after his Tax Court deficiency suit was dismissed for lack of jurisdiction for late filing and where there was no dispute that a notice of deficiency had been issued, Wall v. United States, 141 Fed. Cl. 585 (2019), but the taxpayer in the suit was only seeking relief from liens, not a refund, and, in any event, had not fully paid the deficiency before bringing the suit.

It’s probable that no refund suits resulted from the Tax Court dismissals for failure to timely file the petition because a very high percentage of the petitioners dismissed were pro se taxpayers who lack knowledge of tax procedure and funds to full pay.  Only in a rare cases does the taxpayer benefit from IRC 7459(d), and not one that we know of.  Yet, we know there are cases in which taxpayers could benefit from the interpretation of IRC 6213 as a claims processing rule.

Petitioners who would especially benefit from the interpretation of IRC 6213 as a claims processing rule are petitioners with a good basis for equitable tolling.  While this is not a large number, the individuals with a good reason for filing late present very sympathetic cases in which the petitioners deserve the chance to have the merits of their case heard.  The next post will talk about the equitable tolling rules and who these petitioners might be. 

In addition, petitioners who would benefit are the petitioners dismissed because the Tax Court spent the time and effort to carefully review each case to determine if it had jurisdiction and issued an order to show cause when it had concerns about its jurisdiction even though Chief Counsel did not raise an issue.  In February and March of 2022, Carl searched for this type of order to show cause and found 34 cases.  This means that about 204 petitioners a year might benefit if the Tax Court did not need to spend time carefully scouring each case to check on its jurisdiction.  This would not only give these taxpayers a chance to have the merits of their argument heard but would save the Tax Court all of the time it currently spends looking at each case to determine if it has jurisdiction. 

To determine how many of the cases in which the Tax Court show cause orders resulted in a dismissal, Carl went back to April and May of 2021 expecting that most of those cases would have cleared through the system by now, offering a percentage of cases dismissed after a show cause order.  His research suggests that about 75% of the cases identified were dismissed as untimely.  The 9th Circuit’s effort to “help” taxpayers by citing to IRC 7459(d) instead created a misguided view of the system.  The actual cases show that few, if any, taxpayers receive a benefit from IRC 7459(d) but quite a few taxpayers might benefit from a claims processing rule, either because they have a basis for equitable tolling or, more likely assuming the Chief Counsel attorneys continue to fail to identify issues of timely filing, because taxpayers will no longer face orders to show cause for dismissal for lack of jurisdiction on account of late filing.

You Call That “Notice”? Seriously?

Last April, I wrote (see here and here and here) about the Federal Circuit’s decision in General Mills, Inc. v. United States, 957 F.3d 1275 (Fed. Cir. 2020), aff’g 123 Fed. Cl. 576 (2015).  The briefs on appeal are available here: the taxpayer’s opening brief, the government’s answering brief, and the taxpayer’s reply brief.  This was a complex case, involving the intersection of TEFRA partnership audit procedures and the “large corporate underpayment” (LCU interest, or “hot interest”) provisions of the Code.

There was one argument made by the plaintiff on the TEFRA issue that I addressed rather briefly, because the Federal Circuit simply swatted it away.  That argument really warrants more discussion because it’s a serious problem that goes beyond just this specific context, one that we need to continue challenging: the adequacy of notices to taxpayers.  So let’s talk about that case a bit more.

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The Background

This is a very abbreviated version of the facts, because I want to focus on that one argument General Mills raised and the court rather perfunctorily swatted down.  Interested in more?  Check the opinions or prior blog posts.

The General Mills consolidated group (“GMI”) filed corporate tax returns for the 2002-2003 and 2004-2006 tax years, and General Mills Cereals, LLC (“Cereals”) filed partnership tax returns for the same years.  Various members of the GMI consolidated group were partners in Cereals, so the tax returns—and any audit adjustments—for Cereals flowed through to GMI.  The IRS audited both sets of tax returns for all these years.  Although there are some slight differences between the audits for those two periods, for simplicity I will focus on the 2002-2003 tax returns.

Deficiencies were identified for both the corporate and the partnership tax returns.  As this was back in the days before the Bipartisan Budget Act of 2015, the TEFRA audit procedures were still in effect.  For the remainder of this post, references to Code sections in the 62xx range will be the old, pre-BBA versions, which have been replaced in the current Code by the new BBA procedures.

TEFRA “Computational Adjustments”

TEFRA required “partnership items” to be resolved at a partnership-level proceeding.  After that proceeding ended, the effects of the adjustments to partnership items were translated into partner-level tax liabilities by means of “computational adjustments.”  Notices of deficiency at the partner level are required only if a partner-level “determination” is required; otherwise the IRS can assess immediately.  (Penalties can be assessed immediately even though a partner might raise partner-level defenses in a refund claim/suit.)  Immediately assessable computational adjustments also include “any interest due with respect to any underpayment or overpayment of tax attributable to adjustments to reflect properly the treatment of partnership items.”  Treas. Reg. § 301.6231(a)(6)-1(b).

TEFRA also provided a mechanism for taxpayers to challenge computational adjustments that did not require a deficiency proceeding, in section 6230(c).  The taxpayer must file a refund claim “within 6 months after the day on which the Secretary mails the notice of computational adjustment to the partner.”  Thereafter, a refund suit can be brought within the period specified in section 6532(b) for refund suits.  Section 6511(g) provides that section 6230(c) applies, rather than the two-year period specified in section 6511(a), with respect to tax attributable to partnership items.

You guessed it.  The partners (individual members of the GMI consolidated group) paid the assessed liabilities and then filed refund claims.  Those refund claims were timely under the two-year period in section 6511, but not under the six-month period in section 6230(c).  So GMI had to argue that the longer period applied.

There were a lot of different arguments by GMI that I discussed at length last April.  Here, I want to focus on GMI’s argument that the six-month period never commenced, because none of the communications from the IRS qualified as a “notice of computational adjustment.”

A Brief Pause to Consider Other Types of Notices

A notice of deficiency clearly identifies the tax year, the amount of the deficiency, and the reasons for the deficiency.  The IRS sends it by certified mail.  It clearly identifies what the taxpayer must do to challenge it – file a petition with the Tax Court – and the period within which the taxpayer must do that.  It even calculates the deadline and states it explicitly on the first page, and the taxpayer can rely on that even if the IRS erroneously calculates the date.  Stat notices are not without their flaws, but this is about as good as you could hope for – the “gold standard.”

A notice of determination denying innocent spouse relief can be pretty good too.  The most recent we received, by Letter 3288, was sent by certified mail and clearly identified the tax year(s) at issue and a (too) brief explanation of why relief was denied.  (A request for the administrative file is definitely in order!)  It clearly specified, at the top of page two, the taxpayer’s right to challenge the determination by filing a petition in Tax Court and the period within which the taxpayer must do that.

A notice of intent to levy is, frankly, horrible.  They’re too long and poorly written, hard to understand for a layperson; even for some students at an academic LITC.  They muddle the message by combining requests to pay with notifying the taxpayer of her rights.  The next-to-last notice (CP504) is misleading, as discussed below.  The final notice (LT11, CP90, etc.) explains the right to a CDP hearing reasonably well, including the period within which the taxpayer has to request a CDP hearing, but the message can be drowned out by the scare tactics elsewhere within the notice.  On the positive side, both these notices at least specify their statutory basis – sections 6331(d) and 6330(a) respectively, and both must be delivered personally or by certified mail.  There are other problems with collection notices, but those will do for a start.

Keith has a great blog post here about the distinction between the 6331(d) notice (CP504) and the 6330(a) “final notice” providing the right to a CDP hearing (LT11, CP90, etc.) and the history.  It also points out how misleading, if not knowingly false, the 6331(d) notice is.  Go read Keith’s post now if you haven’t already/lately.  I like to think of the difference as that the 6331(d) notice by itself only allows the limited categories of levy described in section 6330(f), most notably state tax refunds or jeopardy collections.  For those categories, a CDP hearing is available only post-levy.  For all other categories, a CDP hearing is available pre-levy but the IRS must first send the 6330(a) “final notice” to allow the taxpayer to request a hearing.  It’s a bit of a mess procedurally.

Math error notices are . . . well, look at this post by Keith (including the comments and the NTA blog post he links to) for some of the many defects of math error notices. 

Multiple Communications

GMI, on the other hand, was dealing with a notice of computational adjustment.  The Court of Federal Claims and the Federal Circuit considered several of the communications from the IRS to GMI as possible notices of computational adjustment, either separately or collectively, that would have started the statute of limitations running.   

First, on August 27, 2010, the IRS sent a letter with Form 5278, “Statement—Income Tax Changes” enclosed. That form included a line for “Balance due or (Overpayment) excluding interest and penalties” with a corresponding dollar amount, the additional tax owed by the partners from the settlement of the partnership audit.  No amount was shown for interest, but the cover letter stated that the IRS “will adjust your account and figure the interest.” 

The Court of Federal Claims quoted a statement in the earlier Form 870-LT (AD) settlement agreement for the Cereals audit that the taxpayer consented to the immediate assessment of deficiencies in tax and penalties “plus any interest provided by law.”  I emphasized that last phrase because the court did.  Three times, once for each place that phrase occurred on Form 870-LT (AD).  Pause for a moment and consider the reaction if a settlement agreement or notice of deficiency had not specified the exact amount of tax and penalties and merely said “the amount of additional tax and penalties provided by law.”  And here, there was enough ambiguity about what the law provided regarding “hot interest” that “provided by law” was not sufficient anyway.

Second, the IRS assessed the adjustments to GMI’s returns, flowing through from the partnership audit and including interest, on September 3, 2010.  The assessment, of course, would have just shown up as a lump sum.  I defy anyone to reverse engineer the calculations underlying an interest assessment on a large corporate return, including flow-through adjustments from a partnership.  It can be done, but anyone in their right mind would give up long before they reached a solution.  GMI proceeded to pay the assessed amounts on April 11, 2011. 

Finally, on April 18, 2011, the IRS sent GMI detailed interest computation schedules.  As described, those were probably sufficient to identify the IRS application, which GMI disputed, of the “hot interest” provisions.  (This discussion focuses on the 2002-2003 tax years.  For the 2004-2006 tax year, the IRS sent two different sets of interest computation schedules, the first one of which implied that “hot interest” wouldn’t apply at all.)

GMI’s Argument

What was missing from all these communications?  The August 27, 2010, letter didn’t state the amount of the computational adjustment.  The September 3, 2010, assessment gave the total amount of interest assessed, which did not break out the portion attributable to the increased tax and penalties included in the computational adjustment and was insufficient to identify how the IRS calculated that amount.  The April 18, 2011, interest computation schedules did provide sufficient information to identify what GMI considered in error.  None of them were explicitly identified as a “notice of computational adjustment.”  None of them specified the applicable statutory provision.  None of them specified the deadline for filing a refund claim, a deadline that was different from the normal statute of limitations for filing refund claims.

When I compare this notice of computational adjustment (at least with respect to the interest amount) to other notices described above, it seems: (a) significantly worse than the notice of deficiency and an innocent spouse notice of determination; (b) arguably worse than collection notices; and (c) at least as bad as some of the worst examples of math error notices.  Being “no worse than math error notices” is not a good standard for the IRS to strive for.

GMI argued that

a notice of computation adjustment must (1) contain the amount of adjustments, (2) contain a statement of the increased rate of interest that will apply, and (3) provide the partner with some indication that the document is intended to be a notice of computational adjustment that triggers a 6-month period of limitations under § 6230(c)(2)(A).

It cited McGann v. United States, 76 Fed. Cl. 745 (2007) as establishing that standard.

The Federal Circuit Was Not Convinced

The court noted GMI’s arguments but rejected them because those asserted requirements went beyond the statutory text.

GMI contends that the notices were defective for various reasons. First, GMI says that the IRS was required to give notice that “a jurisdictional period was being triggered,” and the schedules failed to mention § 6230(c) or the six-month limitations period. GMI also argues that the schedules were tainted by the failure to mention the Partnership proceedings and the failure to separate the accrued interest on underpayments resulting from the corporate proceedings from that of the Partnership proceedings. These contentions lack merit. The Court of Federal Claims stated that the notice of computational adjustment need not be in any particular form, and we agree. Indeed, the Internal Revenue Code does not define what a notice of computational adjustment should contain.

(citations omitted)  At most, the court would have required “the information [GMI] needed to assess whether the IRS may have erroneously computed the computational adjustment,” but it concluded the various communications provided that.

The court’s apparent conclusion that a notice, unless it is misleading, need only comport with statutory requirements is disturbing.  McGann stands for the proposition that there is a minimum requirement of due process that may exceed statutory requirements.  The Federal Circuit distinguished McGann as involving a misleading notice of computational adjustment and concluded the notices sent to GMI were neither misleading nor contradictory.  It didn’t mention the statement from McGann that “the notice of balance due bears no indication that it is to be taken as a notice of computational  adjustment, nor does it disclose that Mr. and Mrs. McGann would have had to contest any amounts said to be due within a six-months’ period thereafter.”  The McGann court also pointed out that “neither the Form 4549A nor the accompanying Form 886-A previously sent to Mr. and Mrs. McGann contained such an advisory.”  The McGann court also looked to cases involving notices of deficiency as “instructive” in determining whether a notice of computational adjustment was adequate.

Conclusion

I can understand why Congress and the IRS might not specify, and courts might be reluctant to impose, rigorous requirements for notices of computational adjustment.  With respect to additional tax and penalties, the amount of the aggregate adjustment was already determined in the TEFRA proceeding.  The partner-level adjustments seem merely mechanical and unlikely to be in error.  But it doesn’t make sense with respect to complex interest computations, which were not addressed in the TEFRA proceeding.  That rationale is probably also the unstated reason for why the IRS treats math error notices so cavalierly.  But we know those math error notices also increasingly include adjustments that go far beyond the simple mechanical adjustments that have an extremely high likelihood of being correct.

Not only math error notices but also notices of computational adjustments require improvement, beyond the statutory requirements, to protect taxpayer rights.  We can and should work with the IRS and Congress to achieve better notices.  But pushing for the courts to recognize and enforce higher standards is also a worthy fight, even if it may feel like tilting at windmills.

IRC 7459(d) and the Impact of Dismissal

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.

Incapacitation, Death and the End of an Era, Designated Orders November 16 – 21, 2020, Part II

The week of November 16, 2020 was the week preceding Thanksgiving and the Tax Court’s transition to Dawson was looming, which meant orders would no longer be “designated” on a daily basis. The judges knew it may be one of their last opportunities to alert the public (and Procedurally Taxing) to an order. Many lengthy, novel and diverse orders were designated. As a result, my week in November warranted two parts, and this second part is my last post on designated orders ever. I’ve learned a lot over the last three and a half years, and I hope you all have too.

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Answering Interrogatories while Incapacitated

In consolidated Docket No. 26812-12, 29644-12, 26052-13, 27243-15, 5314-16, 5315-16, 5136-16, 5318-16, Deerco, Inc., et al. v. CIR, the case involves the acquisition of a corporation and the subsequent removal of substantial plan assets (over $24 million) from the acquired corporation’s pension plan in 2008.

The petitioner who is the focus of this order was the President of the acquiring corporation and the trustee for the pension plan of the acquired corporation in control of the disposition of assets, so naturally, the IRS is very interested in what he has to say. Unfortunately, he is incapacitated. His counsel answered some of the IRS’s interrogatories on behalf of all the petitioners (individuals and entities) in this consolidated case by stating that they lack information or knowledge.

The IRS and Court find petitioners’ counsel’s answers to be insufficient for a couple reasons:

1) Rule 71(b) requires the answering party to make reasonable inquiry and ascertain readily available information. A party cannot simply state they lack the information without explaining the efforts they have made to obtain the information. Even though the petitioner is incapable of responding, the Court thinks he should have documents or records that would enable his counsel to answer the substance of the interrogatories. Petitioner also had an attorney and accountant assisting him during the transaction at issue, and those individuals may have useful information, documents, or records.

2) The Court also finds the answers are procedurally defective. The procedures, found in Rule 71(c), differ depending on whether an individual or an entity is providing the answer. In this case, petitioners’ counsel has signed under oath the answers on behalf of all petitioners. Counsel is permitted to answer and sign under oath for entities, but not for individuals. Individuals must sign and swear under oath themselves. The petitioner in this case can’t do that, but his wife has been appointed as his guardian, so she can.

There are other issues raised (such attorney-client privilege concerns), but the prevailing message is that the Court thinks petitioner’s counsel can do better and outlines the ways in which they can provide more adequate answers.

We Cannot See A Transferee

In consolidated Docket No. 19035-13, 19036-13, 19037-13, 19038-13, 19058-13, 19171-13, 19232-13, 19237-13,  Liao, Transferees, et al. v. CIR, the IRS tries several avenues to prove that petitioners, who consist of the estate and heirs of a taxpayer who owned a holding company, called Carnes Oil, should be liable as transferees when an acquisition company ultimately sold the company’s assets and tried to use a tax shelter to offset the capital gains.

In this case, initially, a company called MidCoast offered to buy Carnes Oil’s shares. MidCoast has a history of facilitating a tax shelter known as an “intermediary transaction.” In another post for PT (here), Marilyn Ames covers a Sixth Circuit decision in Hawk, which involved MidCoast, intermediary transactions, and some implications under section 6901. In Hawk, the Court affirmed the Tax Court’s decision and held that petitioners’ lack of intent or knowledge cannot shield them from transferee liability when the substance of the transaction supports such a finding.

In this case, petitioners have moved for summary judgment, and their lack of knowledge is one of the factors the Court uses to ultimately determine petitioners should not be held liable as transferees. Petitioners’ case is distinguishable from Hawk, because the Court determines, in substance, the transaction was a real sale.  

Petitioners didn’t accept MidCoast’s offer, but instead accepted an offer from another company called ASI. More details are fleshed out below, but long story short- the IRS argues an “intermediary transaction” occurred. In support of this the IRS insists that the economic substance doctrine (a question of law) and substance over form analysis (a question of fact) show that what looked like a sale of stock for money was really the sale of Carnes Oil’s assets followed by a liquidating distribution directly from the company to petitioners. The IRS seeks to reclassify the estate and heirs from sellers to transferees to hold them liable.

Even viewing the facts in a light most favorable to the IRS, the Court disagrees under both analyses. The heirs reside in different states, so the appellate jurisdiction varies. The Court acknowledges that they may have to contend with subtle conflicts among the jurisdictions, but regardless of the jurisdiction, whether a transaction has economic substance requires a close examination of the facts.

The facts show that when petitioners sold their stock the company still had non-cash assets, and those assets weren’t liquidated until after ASI controlled it. Petitioners also weren’t shareholders of the dissolved corporation, because it continued to exist for over a year after they sold it.

The facts are not clear as to where ASI got the money to pay petitioners, but after tracing the funds from relevant bank accounts, the Court determined it did not come from Carnes Oil, or a loan secured by their shares.

Neither the petitioners nor their advisers had actual knowledge of what ASI was planning to do. The IRS says there were red flags and petitioners should have known, but the Court finds Carnes Oil was a family company using local lawyers in a small town, and the shareholders reasonably accepted the highest bid.

It was a real sale. The company got an asset-rich corporation and petitioners got cash. The Court grants petitioners’ motion for summary judgment – a win for petitioners in an increasingly pro-IRS realm.

Gone and Abandoned

In Docket No. 23676-18, Miller v. CIR, the Court dismisses a deceased petitioner’s case for lack of prosecution despite his wife being appointed as his personal representative. Petitioner died less than a month after petitioning the Tax Court in 2018 and after some digging the IRS found information about petitioner’s wife.

The Court reached out to her and warned that if she failed to respond the case was at risk of being dismissed with a decision entered in respondent’s favor. The Court did not receive a response.

Rule 63(a) governs when a petitioner dies and allows the Court to order a substitution of the proper parties. Local law determines who can be a substitute. The Court’s jurisdiction continues when someone is deceased, but someone must be lawfully authorized to act on behalf of the estate. If no one steps up the prosecution of the case is deemed to be abandoned.

The Court finds petitioner is liable for the deficiency amount, but it’s not a total loss for the estate, because IRS can’t prove they complied with section 6751(b) so the proposed accuracy-related penalty is not sustained.

All’s Fair in Love and SNOD

In consolidated Docket No. 7671-17 and 10878-16, Roman et. al. v. CIR, a pro se married couple with separate, but consolidated Tax Court matters moves the Court to reconsider its decision to deny petitioners’ earlier motions to dismiss for lack of jurisdiction. The motions were disposed of by bench opinion.

The Court reviews the record and determines that petitioner made objections that have yet to be ruled on.

First, however, it explains that there are two procedural reasons for why petitioner motions could be denied. Petitioners filed the present motion under Rule 183, but that rule only applies to cases tried before a Special Trial Judge. Petitioners in this case have not yet had a trial, the bench opinion only exists to dispose of petitioners’ motions to dismiss, so Rule 183 is not applicable. Additionally, the motions for reconsideration were filed more than 30 days after the petitioners received the transcripts in their case, so they were not timely under rule 161.

Even though the motions could be denied for those reasons, the Court goes on to consider the merits of petitioners’ arguments.

Petitioners’ argue that the Court lacks jurisdiction because their notices of deficiency were invalid because they were not issued under Secretary’s authority as required by section 6212(a).   

Petitioner wife argues her notice of deficiency is invalid because it originated from an Automated Underreported (AUR) department and was issued by a computer system, which is not a under a permissible delegation of the Secretary’s authority.  

Petitioner husband’s notice of deficiency was issued by a Revenue Agent Reviewers about a year later. He argues that his notice is invalid because the person who signed the notice was not named on the notice and she did not have delegated authority to issue the notice. The IRS was not sure who issued the notice, but there were three possibilities. Petitioner husband says not knowing who specifically issued the notice constitutes fraud.

After reviewing the code, regulations, extensive case law, and the Internal Revenue Manual the Court concludes both notices were issued under permissible delegations of the Secretary’s authority and the case can proceed to trial.

Orders not discussed:

  • In Docket No. 25660-17, Belmont Interests, Inc. v. CIR, the Court needs more information from the IRS about how it plans to use the exhibits which petitioner wants deemed inadmissible. According to IRS, the exhibits support the duty of consistency related to representations made by petitioner. Petitioner states the exhibits include representations made in negotiations directed toward the resolution of prior cases involving the same or very similar issues and the F.R.E. 408(a) bars their admission.  
  • Docket No. 10204-19, Spagnoletti v. CIR (order here) petitioner moves to vacate or revise the decision in his CDP case based on arguments made in the original opinion which the Court found were not raised during in the CDP hearing nor supported by the record, so the Court denies the motion.
  • Docket No. 11183-19, Bright v. CIR and Docket No. 18783-19, Williams v. CIR, two bench opinions in which petitioners were denied work-related deductions primarily due to lack of proper proof.  

When the “Routine” Morphs into a “Ticket to Tax Court”

We welcome guest blogger Steve Jager.  Steve is a regular reader of PT with a commercial and a pro bono tax practice.  He devotes a lot of time to the LITC at California State University Northridge [known as the Bookstein LITC], serving as one of their “Tax Court Advisors”  and regularly working with clinic staff/students and clients in resolving issues. He is also a partner in private practice with the firm of Fineman West & Company, LLP.  Although licensed as a CPA, he has passed the test to practice before the Tax Court which a small percentage of practitioners pass each time the Court offers the test.

Steve brings us the story of one of his clients driven to Tax Court by the pandemic and the inability of the IRS to process its mail.  Steve’s case probably represents one of many in this situation where taxpayers receive a notice of deficiency (or notice of determination) not through any fault of their own or of the IRS but because the significant delays in processing mail cause the IRS system to move the case into the deficiency procedure process rather than allowing resolution at the administrative stage.  This by-product of the pandemic certainly occurred in pre-pandemic times but not to the extent of the current level of cases caused by the failure to match correspondence which could resolve the case with the taxpayer’s file.  This causes extra work for the practitioner which is not compensated in the current attorney fee structure, extra anxiety for the taxpayer (and costs) and extra work for Chief Counsel attorneys forced to work on cases that would have been resolved at a lower level.  Taking the case to Tax Court does buy a taxpayer the personal service of an attorney or paralegal rather than the impenetrable correspondence unit of a Service Center but at a high price for all.  Hopefully, the cost here will obtain for Steve’s client the desired result.  Because the client paid the tax prior to the mailing of the notice of deficiency, I expect the IRS will file a motion to dismiss.  Keith

I feared it could happen, but prayed it would not.  I knew the cogs in the IRS machinery were still churning out Notices, and I also knew that the IRS was not keeping up with all the correspondence it was creating with these Notices and I wondered what would happen IF an IRS failure to quickly process a reply to Notice CP2000 occurred…   And then it did. 

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Most of us are probably already familiar with the CP2000 Notice – that Notice that the IRS uses when a “routine matching” of the W2’s and 1099’s are matched up against the tax returns that are filed, and when there is a “mismatch,” the letter that is sent out to the Taxpayer is the CP2000, which assumes that the “mismatch” is unreported income (or an incorrectly deducted interest expense amount), and the IRS gives the taxpayer the opportunity to either pay the calculated tax or otherwise offer explanations as to why the “mismatches” are already reported or not taxable or correctly deducted, as the case may be.  So the possible responses from the Taxpayer (or his/her practitioner) would be either: (i) concession of the amount requested, with or without payment of the additional tax; or (ii) partial concession with a full explanation as to why the concession was only partial – i.e., agreeing with one or more, but not all of the adjustments proposed by the IRS; or (iii) no concession due to a full explanation as to why the proposed adjustments are not correct.    Under “normal” conditions [read that as prior to the pandemic], any of those responses made within 30 days would be considered and at least acknowledged by the IRS.  This, of course, would mean that someone at the Service Center has opened the mail, read the response and within those 30 days, has generated a reply letter back to the Taxpayer.  

But what happens now when the IRS is behind in opening mail, reading the correspondence and writing replies?

Well, it would appear that under the current conditions the CP2000 “machinery” is assuming there has been no response and “pulling the trigger” by issuing the Statutory Notice of Deficiency!  Yikes!  Once the IRS has issued a Statutory Notice of Deficiency, it is really hard to convince the IRS to rescind the Notice (made especially hard, once again, by the fact that the IRS is not running at full capacity), so the Taxpayer has little choice except to file a petition with the United States Tax Court.  Let me relate my own clients’ story.  

Let’s call these clients, Mr. and Mrs. Taxpayer.  When I prepared their 2018 income tax return, I was unaware that Mr. Taxpayer had begun receiving social security income during that tax year, and he did not give me the 1099 from the Social Security Administration, and I certainly did not know to ask him for it.  Therefore, that income was omitted from the tax return.  The IRS computer, however, when matching the social security administration payments against the tax returns, realized a “mismatch,” and a CP2000 was issued last October.  My client received the Notice and contacted me, whereupon we quickly figured out that the income should have been reported, but was not, so I instructed my client to write a check for the tax and the interest as calculated by the IRS.  My client wrote that check IMMEDIATELY, and mailed it with the correct payment stub to the address, as instructed by the IRS.    The IRS cashed the check within 7 days of its receipt, so we know they are still opening the mail quickly, but then things obviously break down.  Notwithstanding the fact that I have had to elevate this to the Tax Court (more on that in a moment), the truly insidious part of this now all-too-common saga, is that the IRS had apparently not credited the payment to the account for Mr. and Mrs. Taxpayer, which resulted in the Statutory Notice being issued!  Once the check was noted as received, I must ask why the IRS machinery wasn’t stopped?

Regardless of why this has happened despite Mr. and Mrs. Taxpayer’s compliance, the reality is that I have had to file a Petition in the Tax Court.  This was certainly not my first petition filed with the Court, but it is my first which was filed electronically, pursuant to the new DAWSON system which the Tax Court has been so excited to roll out.  Preparing the petition was exactly the same as before – that is to say that the Petitioner or practitioner still drafts the Petition as before, and merely uploads the petition as a pdf file, which is a fairly simple process.  Paying the $60 filing fee, which in the past would have been paid by writing a check out of my Client Trust Account, was fairly easy to do by establishing an account with Pay.gov.

Now that the Petition is filed and the IRS is “served,” relatively expensive IRS resources are going to be needed.  Since I have asked for the Trial to be conducted in Los Angeles, I believe that at least a paralegal will need to be conscripted into drafting the Answer to the Petition.   Once that has happened and the Commissioner and my clients are “at issue,” only then will I be able to offer the copy of Mr. and Mrs. Taxpayer’s canceled check to prove that they timely paid the tax that they conceded as soon as they were notified, plus interest.

In this case, my clients, Mr. and Mrs. Taxpayer, are fortunate.  They are being represented and I expect to resolve this case easily.   But how many other folks are there who are compliant, law-abiding taxpaying citizens who will also need to go through a similar ordeal on their own…  unless, of course, they find their way (and are eligible for services) by one of the many LITC clinics.  And for those who do not qualify for LITC Service?   How much will those folks need to pay a professional lawyer or qualified Tax Court practitioner if they wish to be represented?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Prior Opportunity

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

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

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

Designation of Payments

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Second Circuit Reverses Tax Court in Borenstein

This post got lost and so comes onto the site about six months after I wrote it, but it still might be of interest to some.  Thanks to Jack Townsend for asking about it.  I wrote it just before I took off on my cross country bicycling trip and failed to keep a good track on it as it went to my research assistant.  Keith

The Tax Court held in Borenstein v. Commissioner, 149 T.C. 263 (2017) that a taxpayer who filed her return late and after the IRS had issued a notice of deficiency could not obtain a refund given the specific timing of her late return and the notice of deficiency.  We discussed the case here.  The interpretation of the IRS and the Tax Court in the case created an odd “donut-hole” in the statute during which the taxpayer could not file a late return and obtain a refund if during the applicable time the IRS had sent a notice of deficiency.

The Tax Court reached the decision in the case by interpreting the plain language of the statute and applying an interpretive maxim.  The Second Circuit did not find the language as plain or the maxim as applicable and reversed the decision of the Tax Court allowing Ms. Borenstein to receive a refund of almost $40,000 plus interest.  The tax clinic at the Legal Services Center of Harvard partnered with the tax clinic at Georgia State to file an amicus brief in support of Ms. Borenstein because we thought his issue likely to impact low income taxpayers.

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Ms. Borenstein filed a request to extend the time to file her 2012 individual income tax return from April 15, 2013 to October 15, 2013.  Even though she timely and properly filed the request for an extension of time to file her return, she failed to file the return by the extended due date.  She had a lot of stock sales.  The IRS assigned a zero basis to the stock and eventually sent her a notice of deficiency stating that she owed over $1 million in taxes largely resulting from the sale of stock.  The IRS sent the notice of deficiency on June 19, 2015.  Ms. Borenstein filed her return, showing an almost $40,000 refund because her stock did not have a zero basis, on August 29, 2015.

Because of the timing of the notice of deficiency and of the late filed return, the IRS took the position that IRC 6213(b)(3) prohibited her from obtaining a refund.  The facts in the case were not in dispute.  The only issue was the interpretation of the statute and whether it created an unusual donut-hole time period during which a taxpayer could not file their return and obtain a refund, as the IRS argued, or whether the taxpayer had a continuous time period within which to file the return and still obtain a refund. 

Because this is the first and only case seeking an interpretation of the statute on this issue and because the administrative importance is low as signaled by the lack of litigation over the 20-year span since the statutory provision at issue came into existence, it seems extremely unlikely that the IRS will seek certiorari in this case.  Whether it will make the same argument if the issue arises in another circuit remains to be seen.  I hope that the opinion will cause it to rethink its position.

Congress took a look at IRC 6213 and the refund provision in it after the Supreme Court decided the case of Commissioner v. Lundy, 516 U.S. 235 (1996).  Lundy involved the look back period for refund claims and produced a surprising result causing the changes to the statute.  The Second Circuit described the Congressional intent in changing the statute as follows:

A taxpayer who files a tax return, and within three years after that filing is mailed a notice of deficiency from the Commissioner, is entitled to a look‐back period of at least three years. However, prior to Congress’s amendment of the governing statute, a taxpayer who had not filed a return before the mailing of a notice of deficiency‐‐like Borenstein‐‐was entitled only to a default two‐year look‐back period. Accordingly, Congress, seeking to extend the look‐back period available to such non‐filing taxpayers, provided that if a notice of deficiency is mailed “during the third year after the due date (with extensions) for filing the return,” and if no return was filed before the notice of deficiency was mailed, the applicable look‐back period is three years. This is called the “flush
language” of 26 U.S.C. § 6512(b)(3).

Ms. Borenstein filed her return during the third year after the original due date of the return and after the notice of deficiency.  If Congress had not changed the statute, the Lundy case would have prevented her from obtaining a refund because she filed the return more than two years after the original due date and after the issuance of the statutory notice.  She argued that the change in the statute opened the door for her to obtain the refund, but the IRS said if you carefully looked at the statute it did not work that way for someone who had requested an extension of time to file the return and then filed late.  Looking at the language of the statute quoted above, the IRS argued and the Tax Court accepted that:

“(with extensions)” has the effect of delaying by six
months the beginning of the “third year after the due date, ….”

Under this interpretation, the Tax Court could only look back two years. She had no payments within the two-year period as her payments were deemed made on the original due date of the return.

Borenstein looked at the statute and found different meaning:

Borenstein argues that “(with extensions)” has the effect of extending by six months the “third year after the due date,” and therefore that the notice of deficiency, mailed 26 months after the due date, was mailed during the third year. That would mean that the Tax Court has jurisdiction to look back three years, which would reach the due date and allow Borenstein to recover her overpayment.

The Second Circuit sided with Borenstein but examined the Tax Court decision and explained why it disagreed with that decision.  It described the Tax Court’s basis for the decision as follows:

[T]he Tax Court determined that the meaning of the flush language of 26 U.S.C. § 6512(b)(3) is unambiguous, relying heavily on the canon of statutory construction known as the “rule of the last antecedent” to find that “(with extensions)” modifies only “due date.” However, that canon “is not an absolute and can assuredly be overcome by other indicia of meaning.” Barnhart v. Thomas, 540 U.S. 20, 26 (2003). Here, it does not yield a clear answer.

What the Tax Court found clear, the Second Circuit did not:

While the Tax Court determined that “(with extensions)” modifies the noun “due date,” it is at least as plausible that “(with extensions)” modifies the phrase “third year after the due date,” thereby extending the third year. Accordingly, because the flush language of 26 U.S.C. § 6512(b)(3) supports more than one interpretation, we “consult legislative history and other tools of statutory construction to discern Congress’s meaning.” 

Once it determined it could look at legislative history, the Second Circuit determined that in amending IRC 6213(b)(3) after Lundy, Congress was trying to create a path for taxpayers to have a three-year lookback period in Tax Court in order to obtain their refund.  Congress did not like the fact that a taxpayer had been cut off from obtaining a refund just because the IRS had sent a notice of deficiency prior to the end of three years from the original due date.  Cutting off taxpayers who received a notice of deficiency created disparate treatment among taxpayers who were similarly situated.  Given the Congressional goal in amending the statute, it makes the most sense to read the statute in the way proposed by Ms. Borenstein.  Of course, the Second Circuit needed to throw in a maxim that supported its conclusion and in doing so gave some good language to taxpayers for future cases:

Our conclusion is supported by “the longstanding canon of construction that where ‘the words [of a tax statute] are doubtful, the doubt must be resolved against the government and in favor of the taxpayer,’” a principle of which “we are particularly mindful.” Exxon Mobil Corp. & Affiliated Cos. v. Comm’r of Internal Revenue, 689 F.3d 191, 199‐200 (2d Cir. 2012) (quoting United States v. Merriam, 263 U.S. 179, 188 (1923)). As Borenstein notes, the Tax Court’s interpretation creates a six‐month “black hole” into which her refund disappears, a result that unreasonably harms the taxpayer and is not required by the statutory language.
 
Moreover, the interpretation we adopt is consistent with the language of 26 U.S.C. § 6511(b)(2)(A), which provides for a look‐back period “equal to 3 years plus the period of any extension of time for filing the return.” 26 U.S.C. § 6511(b)(2)(A) (emphasis added). In view of our obligation to resolve doubtful language in tax statutes against the government and in favor of the taxpayer, we conclude that “(with extensions)” has the same effect as does the similar language that existed in § 6511(b)(2)(A) at the time of § 6512(b)(3)’s amendment‐‐that is, the language expand.

The Second Circuit opinion makes sense to me.  I think it achieves the intent of Congress in “fixing” the statute after Lundy.  It also avoids what seems like an absurd result the IRS interpretation achieves by avoiding the six month black hole or donut hole.  Taxpayers should file their returns on time.  If they do not file on time, they can suffer significant consequences including the total loss of their refund if they wait too long.  Taxpayers, however, should receive three years within which to file their late returns and still receive a refund whether or not the IRS issues a notice of deficiency. 

Losing Jurisdiction through Excessive Payments – Designated Orders: May 27 – 31, 2019

Another week with only two designated orders (likely caused by the Memorial Day holiday). The first comes from Judge Carluzzo, but is a fairly unremarkable order that grants a petitioner’s motion to dismiss his own CDP case. There was a motion for summary judgment pending from Respondent; perhaps Petitioner agreed to a collection alternative or otherwise came to a realization that defending against summary judgment would be futile. We don’t know, as there remains no electronic access to documents on the Tax Court’s docket other than orders and opinions.

The other order from Judge Leyden likewise dismisses a case, but for a different reason: the petitioners in this deficiency case had paid the Service’s proposed tax before it issued a notice of deficiency. Nevertheless, the Service ended up issuing a Notice of Deficiency, from which the Petitioners timely petitioned the Tax Court.

Ordinarily, when dealing with jurisdictional motions in the deficiency context, we see two failures of jurisdiction: (1) the Petitioner hasn’t timely filed their petition, or (2) the Service issued an invalid notice of deficiency—most often because the Service failed to mail the notice to the Petitioner’s last known address.

Here, Respondent filed a motion to dismiss for lack of jurisdiction. Judge Leyden finds the Notice of Deficiency is invalid, but not because it was inappropriately mailed. Rather, the Notice is invalid because, the Court concludes, no deficiency exists.

Conceptually, this feels a bit like putting the cart before the horse. Isn’t the question of whether a deficiency exists a determination to be made on the merits? Why is the Court deprived of jurisdiction? Payment of a deficiency and the deficiency itself seem to be independent concepts. Why is the Tax Court not empowered, as a statutory matter, to determine the propriety of a deficiency—even if it’s been paid before the Notice of Deficiency is issued?

The Court doesn’t cite to any caselaw in the order, but a number of Courts of Appeals agree with Judge Leyden’s analysis. For example, in Conklin v. Commissioner,  897 F.2d 1027 (10th Cir. 1990), a Notice of Deficiency was issued for a joint liability. However, prior to the Notice of Deficiency, the wife paid the entire proposed joint liability in full. The husband sought to challenge the liability in Tax Court. The Tax Court determined the merits of the issue, but the 10th Circuit reversed, holding that the no deficiency existed under I.R.C. § 6211, because it had been fully paid prior to the husband’s Notice of Deficiency. Therefore, the Tax Court had no jurisdiction to hear the case and determine the merits.

What’s the statutory underpinning of this decision? It begins and ends with IRC § 6211, which defines a deficiency. I teach this section each year to my Tax Clinic class, which results in some mild bewilderment. Let’s look at the statute:

For purposes of this title in the case of income . . . taxes imposed by subtitles A… the term “deficiency” means the amount by which the tax imposed by subtitle A …exceeds the excess of—

  • The sum of  
  •  The amount shown as the tax by the taxpayer upon his return . . . plus
  • The amounts previously assessed (or collected without assessment) as a deficiency, over—
  • The amount of rebates, as defined in subsection (b)(2), made.

Clear as mud. I try to frame this as a mathematical equation in class. As elements in the equation, we have:

  1. TaxA: The tax imposed by subtitle A—i.e., what the tax actually should be, under the Internal Revenue Code;
  2. TaxR: The amount shown as the tax by the taxpayer upon his return;
  3. A: Amounts previously assessed as a deficiency;
  4. C: Amounts collected without assessment—the critical issue in this order; and
  5. R: The amount of rebates.

As much as I try to tell students wanting to enroll in Tax Clinic that there’s minimal math involved, it’s time to express this as a proper equation.

Deficiency = TaxA  – ((TaxR  + A + C) – R)  

And, remembering with much appreciation my high school algebra classes, we can simply the equation as follows:

Deficiency = TaxA  – TaxR  – A – C + R  

(My wife—who majored in mathematics—tells me that this is an example of the “distributive property”.)

For simple cases, this makes some conceptual sense. A deficiency primarily equals the tax under subtitle A, less the tax that the taxpayer reported on the tax return.

Let’s add some complexity. If there were previous deficiency assessments made, then those amounts should be reduced from the new deficiency. If there were rebates made (as would occur if, for example, a previous audit resulted in an additional refund to the taxpayer), those amounts should be added to the new deficiency.

That brings us to the issue in this case—“amounts previously . . . collected without assessment.” Those too must be reduced from the definition of a deficiency under section 6211. And if the Notice of Deficiency is issued after the “amounts collected without assessment” exceed the amount of any proposed deficiency, then no deficiency existed when the Notice was issued—or at least, no deficiency that the Commissioner is asserting.  In effect, the Notice is asserting something that cannot exist under section 6211, and it’s therefore invalid. In contrast, if payment occurs after the Notice is issued, the Notice itself remains valid as a deficiency existed at the time of the Notice.

Ultimately, taxpayers in this situation still have an option to dispute the merits of an IRS audit determination: they may file a refund claim with the Service and (upon denial) sue for a refund in District Court or the Court of Federal Claims. This isn’t the most helpful result for pro se taxpayers, given the relative procedural complexity in those courts. Yet, it remains the sole option for these taxpayers.

There are some practical problems with this approach, however. In Judge Leyden’s order, the Petitioners didn’t object to Respondent’s motion. Presumably they agreed that they owed a deficiency, had paid it, and wanted to simply finalize the matter with the IRS.

But there’s still a potential problem. The Service issued a Notice of Deficiency several months after the Petitioners fully paid the proposed deficiency. It seems likely that when they made the payment the Petitioners would have signed Form 4549, Income Tax Examination Changes, which waives the restrictions in section 6213 on assessment and collection. If they did, and the IRS made an assessment pursuant to the Form 4549 at that time, then there is potentially a risk that the Service could assess the same tax again subsequent to the Notice of Deficiency. Stranger things have happened; indeed, Judge Leyden references this possibility in the order itself, and notes that the Service has assured the Court it will take care not to make a duplicate assessment.

What happens if the Service does make that mistake? Can the Petitioner return to Tax Court to enforce the Service’s promise reflected in the order? Maybe, as a practical matter. Perhaps the Court would exercise such jurisdiction as in similar cases involving improper mailings that invalidate the Notice of Deficiency.

At present, this case represents a cautionary tale to taxpayers and their representatives wishing to dispute a tax deficiency in the U.S. Tax Court, yet also wish to prevent the running of penalties and interest. Either (1) they should designate their payment as a “deposit” or (2) they should wait until after issuance of the Notice of Deficiency to make payment. Otherwise, any dispute is heading to District Court or the Court of Federal Claims.