Nominal Qualified Offers and TEFRA

We welcome guest blogger Ted Afield. Professor Afield directs the low income taxpayer clinic at Georgia State. The Georgia State tax clinic serves more clients that almost any clinic in the country and provides them with high quality service. The tax clinic at the Legal Services Center at Harvard and the Georgia State tax clinic have partnered on several amicus briefs and it’s always a pleasure to work with their clinic. The case discussed by Professor Afield provides important precedent for successful litigants seeking to recover fees after making a qualified offer. Paying attorney’s fees to a partnership that engaged in an abusive tax shelter promotion makes for a tough pill for the government to swallow which, I believe, caused it to argue the issues discussed here so vigorously. Even though I do not support the underlying tax position taken by the partnership, it had the winning issue on the statute of limitations and that formed the basis for successful litigation on the attorney’s fees issue. Perhaps the benefit of this opinion for parties seeking fees will outweigh the loss to a tax shelter promoter. Keith

The United States Court of Appeals for the Federal Circuit recently issued an opinion in BASR Partnership, William F. Pettinati, Sr., Tax Matters Partner v. United States, in which the court determined whether a partnership was entitled to recover its reasonable litigation costs from the government when it submitted a nominal $1 qualified offer to the government in tax controversy litigation and subsequently prevailed at summary judgment.   This case was a Son of Boss case in which the IRS waited a decade before issuing a Final Partnership Administrative Adjustment (FPAA) disallowing BASR Partnership’s tax benefits.  Accordingly, the tax matters partner, William Pettinati, Sr., challenged the FPAA as untimely pursuant to the three year statute of limitations in IRC § 6501(a).  Given the confidence that the BASR partners had in their statute of limitations argument, they submitted a $1.00 qualified offer to the government, which the government rejected.  As it turns out, the BASR partners’ confidence was indeed justified, and they prevailed on summary judgment and then moved for an award of litigation costs under IRC § 7430(c)(4)(E), which the trial court granted. 

On appeal, the government raised five arguments for why the court should not have awarded litigation costs, three of which being of particular interest in that they explore the relationship between TEFRA and qualified offers as well as whether nominal offers are in fact permissible.  The government’s first argument was that BASR was not a “party” in the litigation because of TEFRA and therefore could not be a “prevailing party” as required under the qualified offer statute.  The government’s second and third arguments were that, even if BASR was a “party,” the tax liability was not “in issue” and BASR did not incur any litigation costs during the underlying TEFRA proceeding.  The government’s remaining arguments were that, even if IRC § 7430(a)’s eligibility requirements were satisfied, the trial court did not apply the real-party-in-interest doctrine and abused its discretion in granting the award.  These arguments presented an opportunity for the Federal Circuit to examine how the TEFRA and qualified offer rules interact with each other and, of particular interest to me and Keith, presented an opportunity for the court to determine whether nominal qualified offers, which are often utilized by low-income taxpayer clinics, would be considered per se unreasonable. 

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The Underlying Partnership is a Prevailing Party 

 The court rejected the government’s argument that only individual partners, rather than the partnership itself, can be parties in a TEFRA proceeding and that, accordingly, BASR Partnership could not be a “prevailing party.”  The court noted that the language in IRC § 6226 that permits individual partners to participate in the proceeding should be read inclusively rather than exclusively (i.e., just because the statute specifically indicates that partners can be parties, that does not mean that it prevents the partnership itself from also being a party).  The court noted that the cost-shifting language of IRC § 7430(c)(4)(A)(ii) supported this interpretation of IRC § 6226 because it specifically contemplated “any partnership” as being included in the definition of “prevailing party.” 

Tax Liability is “In Issue” in a TEFRA Proceeding 

 After determining that BASR Partnership could indeed be a prevailing party, the court next had to consider whether the tax liability was “in issue” in a TEFRA proceeding.  The government contended that the liability was not “in issue” because the tax liability is determined at the partner level rather than at the partnership level in such proceedings.  The Court rejected this narrow reading of the phrase “in issue”, however, and held that actual liability would not have to be determined at the partnership level for it to be “in issue”—rather, it was sufficient that the partnership determination would impact the partners’ individual tax liability. 

The partnership incurred litigation costs despite the fact that the costs were incurred in the partner’s name, and the partnership was the “real party in interest” 

Because the resolution turned more on an issue of contract and state partnership law than an issue of tax procedure, I will not overly dwell on the government’s argument that the partnership did not incur any litigation costs because the costs were incurred by the managing partner individually and the argument that the “real party in interest” doctrine prevented a recovery of costs because the real parties in interest were the partners, whose net worth would have made them ineligible to recover costs under IRC § 7430.  Suffice to say that the court rejected these arguments because the managing partner had brought an action in his capacity as tax matters partner under IRC § 6226, and the partnership agreement and the relevant state partnership law (in this case, it was Texas) obligated the partners to reimburse him for litigation costs.  It is worth noting, however, that the “real party in interest” issue is the one that provoked a dissenting opinion arguing that the fact that the partners were entitled to have their litigation costs reimbursed by the partnership made them the true beneficiaries of the award and thus the real parties in interest. 

Awarding litigation costs was not an abuse of discretion (i.e., the issue causing low-income taxpayer clinics to weigh in) 

The government’s final argument was that awarding litigation costs constituted an abuse of discretion because the taxpayer’s nominal $1.00 qualified offer “was not made in a good-faith attempt to produce a settlement.”  This was the argument that got Keith’s and my attention, because it seemed to us that the government was attempting to argue that nominal qualified offers were per se invalid.  If successful, this argument could have severely hindered a common litigation strategy that low-income taxpayers employ in frozen refund litigation.   

 Accordingly, our clinics (the Philip C. Cook Low-Income Taxpayer Clinic of Georgia State University College of Law and the Harvard Federal Tax Clinic) filed a joint amicus brief in this case solely on the issue of whether taxpayers should be denied reasonable litigation and administrative costs based on the dollar value of a qualified offer.  The clinics argued that none of the requirements of IRC § 7430 state that an offer must be of a minimum amount or of a minimum percentage of the taxpayer’s possible liability in order to be valid.  The clinics were particularly concerned with the potential impact that a rule requiring a minimum qualified offer amount would have on low-income taxpayers, which motived them to submit the brief. Low-income taxpayers who have had their refunds frozen often submit $1 qualified offers when they believe that they will prevail in a tax court case in order to shorten the time it takes for them to resolve their case and receive their frozen refund.  Obtaining these frozen refunds is of critical importance to these vulnerable taxpayers because they often need the tax refunds generated by the earned income tax credit to meet their basic living expenses.  Submitting a qualified offer puts pressure on the government to consider the low-income taxpayer’s case more quickly than it otherwise would because of the risk that the government would have to pay fees and costs if the taxpayer prevails.   

 In looking at this issue, the court agreed that a nominal $1 qualified offer can be reasonable and that awarding litigation fees was not an abuse of discretion.  While the court did not discuss the impacts to low-income taxpayers directly in its opinion, the clinics are pleased that the court reached this result and that nominal qualified offers will remain a viable litigation tool for low-income taxpayers who rely on them to obtain improperly frozen refunds as quickly as possible. 

 

 

Ninth Circuit’s Opinion in Altera Withdrawn

Susan Morse and Steve Shay wrote last week about the significant Ninth Circuit opinion reversing the fully reviewed and unanimously decided Tax Court case in Altera. Earlier today the Ninth Circuit withdrew the July 24th opinion to allow time for a newly reconstituted panel to confer about the appeal.  The order occurred because Judge Stephen Reinhardt, one of the judges in the majority in the 2-1 decision, passed away five months after oral argument and before the publication of the opinion.

On August 2 the court issued an order selecting Judge Susan P. Graber to replace the late Judge Reinhardt on the three-judge panel in the case citing chapter 3.2(h) of the Ninth Circuit General Orders. This section provides that if a member of a three-judge panel becomes unavailable for certain stated reasons , including death, “the Clerk shall draw a replacement as needed, utilizing a list of active judges randomly drawn by lot.”

These events provide even more excitement for a case that did not need more procedural turns to draw attention to its importance.

Some Tax Court Geography

We welcome back as a guest poster frequent commenter Bob Kamman.  Those of you who are regular readers of the blog know that Bob has a sharp eye and an inquisitive mind. He saw in a designated order post the statement by the National Taxpayer Advocate that her office is looking to add a tax clinic to Hawaii. Drawn to the beautiful islands, Bob began to do his research about the tax issues he might face should he seek to establish a low income taxpayer clinic (LITC) in that state. I think he is sharing the information in case there are other readers who might also be interested. As you can see from our prior post, Hawaii is not the only state looking for an LITC. Keith

The seas are infested with sharks. The land is scorched by flowing lava. It is no place for a young person. But volunteers are needed. So in the twilight of my tax years, I could accept the risks. The National Taxpayer Advocate has asked for help with establishing a low-income taxpayer clinic in Hawaii, and I am ready. I understand grant money is available.

First, of course, I checked out whether there is really a need for tax help in the middle of the South Pacific. Does federal enforcement of tax laws really extend that far?

One measure of need (and there are probably better ones) is the number of Tax Court petitions filed from a place. The Tax Court website provides an easy, although somewhat inaccurate count. A “Docket Inquiry” yields the number of petitioners from each state. Of course, in many cases there are two names for each petition because of joint returns, or multiple petitions for the same issue, if partnerships and their members are counted.

Yet you can imagine yourself at the Tax Court door, watching about 100 people file their petitions each business day (mostly, by mail or delivery service), and asking, “Where do they all come from?”
And it is of some interest, at least to me, if there are geographical differences in the origins of these tax disputes.

So here are the results of my research. I started with the 2017 rank by population of each state, along with the District of Columbia and Puerto Rico. And then I found how many petitioners came from each location, so far this year.

This method works for most states, but not the ten largest by petitioner count, because the Tax Court docket inquiry function lists only the first 500. So those were ranked according to earliest date of the first 500 petitions.

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What stands out from this table is that nothing much stands out. With few exceptions, the results are about what you would expect.

Some states rank five or six places lower in petitioner count than in population rank. It is not unreasonable to assume that compliance levels are higher in them: Kentucky, Alabama, North Carolina, West Virginia, Indiana, Nebraska, Wisconsin and Maine. Or, you could assume that a higher percentage of rural residents discourages trips to Tax Court trial sites.

Delaware ranks five places higher, and Maryland eight places higher, in petitioners compared to population. Delaware is home to many corporations, but most file from some other state. The IRS Baltimore District used to administer Washington, D.C., also. Maybe the IRS staffing in Maryland is still weighted more heavily than needed.

And then there are the four contiguous Western states where petitioner rank significantly exceeds population rank: Utah, Nevada, Colorado and Arizona. What do they have in common? A low percentage of rural residents. Someone with more access to data than I have, should research what percentage of Tax Court cases are filed by taxpayers who live within a two-hour drive of the courthouse.

Of course, for most of Hawaii trial attendance requires a flight to Oahu. But there are still more petitioners in Hawaii, than in twelve other states; Washington, D.C.; and our Atlantic islands of Puerto Rico. Help is definitely needed. I am just waiting for a call.

Attorney’s Fees Awarded in Penalty Case Arising From Late Payment of Excise Taxes

As in Keith’s post yesterday, today’s post also involves attorney’s fees, though the subject of toady’s post, C1 Design Group v US, involves a qualified offer and whether the awarding of fees justifies a rate higher than the statutory cap of $200/hour. C1 Design Group is a magistrate’s order from a federal district court in Idaho, and as I describe below is a helpful case for practitioners wanting insights into recovering attorney’s fees under Section 7430.

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The underlying case involved a refund action that considered whether C1 Design’s failure to timely pay its excise taxes was due to willful neglect. C1 argued that a car crash involving the company’s founder led to financial difficulties, which led to the late excise tax payments. IRS agreed with that excuse for the first four quarters but litigated the effect of the crash on later quarters. The taxpayer argued that the injury triggered financial difficulties, which amounted to reasonable cause for the late payments.

The matter went to trial, with a jury rendering its verdict in favor of the taxpayer for the full amount of the refund, about $28,000. About a year after filing its claim, C1 Design made a qualifying offer, essentially agreeing to accept as a settlement a refund of about half of what the jury found the taxpayer was ultimately entitled to receive.

Following the verdict, C1 Design filed its motion for fees, seeking about $76,000; approximately $50,000 was attributable to the period after it made the qualifying offer.

The court agreed that C1 was entitled to fees for the period after the IRS  rejected the qualifying offer, but found that rejecting the offer was “substantially justified”, thus not warranting fees for the period prior to the qualifying offer. In addition, the court reduced the lead lawyer and his associates’ hourly rate, based on a finding that the taxpayer did not prove that there were special factors that warranted an increase over the statute’s $200 cap. The net result was that the taxpayer was awarded attorneys’ fees of about $33,000, not the $70,000 that the taxpayer sought.

There are some things in the opinion worth highlighting.

One, just because a taxpayer wins on the merits, it does not mean that the government position is not substantially justified, especially on a fact intensive issue like reasonable cause involving late payment penalties. As the opinion discusses, the “United States’ position was substantially justified if it is ‘justified to a degree that satisfies a reasonable person,’” or has reasonable basis in both law and fact. Pac. Fisheries Inc. v. United States, 484 F.3d 1103, 1108 (9th Cir. 2007) (citing Pierce v. Underwood, 487 U.S. 552 (1988). That inquiry, under the statute, has a focus on whether the “United States has lost in courts of appeal for other circuits on substantially similar issues.”

In this case (as in most), the judge deciding the fees motion presided at the trial. She noted that while the taxpayer won, its victory was “no slam dunk” for either side. Pointing out evidence that favored the government, including the taxpayer’s decisions to pay other creditors and pay healthy salaries while not paying Uncle Sam, the magistrate judge emphasized that had the taxpayer’s main witness (the person whose crash caused the taxpayer’s financial spiral) been less credible, the US would have won on the merits.

The order also discusses the lack of circuit court authority on the issue as to whether financial difficulties equate to reasonable cause for late payment of excise taxes; the slim authority the taxpayer relied on was out of the Third Circuit and involved an analogous issue, employment taxes rather than excise taxes.

Finally worth noting is the court’s unwillingness to allow the full hourly rate for the partner and associate’s fees. The statute caps the fees at $200/hour; the taxpayer sought the $300 that the partner charged and that were the bulk of the fees. Section 7430 provides that the $200 cap is what the taxpayer gets “unless the court determines that a special factor, such as the limited availability of qualified attorneys for such proceeding, the difficulty of the issues presented in the case, or the local availability of tax expertise, justified a higher rate.”

To justify the fee, the lead attorney filed an affidavit, stating that he practiced law for over 37 years, that for the last 16 years his main focus was tax resolution and that his fees were equivalent to what other attorneys with similar expertise charged. For good measure he noted that he believed he was only one of a couple of attorneys in the Idaho area that “solely represents” clients in tax controversy matters.

The order found that the affidavit was insufficient:

While Mr. Martelle [the partner] “believes” he is one of few tax attorneys in the Boise, Idaho market, he does not identify in his affidavit who those other attorneys are or the rates charged by those attorneys. Mr. Martelle’s belief, without other evidence to corroborate it, is not sufficient to establish that Boise, Idaho, is lacking in qualified tax attorneys. Moreover, the Court finds the issues presented in this matter were not so difficult as to warrant an upward adjustment of attorney fees. The issues presented were not technical—neither side found it necessary to hire an expert, and the trial (including deliberations) was over in just two days. Finally, while the Court does not doubt Mr. Martelle’s vast experience in tax law, such expertise alone is not a special factor to justify attorney’s fees in excess of the statutory cap. For these reasons, the Court will award attorney’s fees at the maximum statutory rate of $200 per hour for Mr. Martelle.

Conclusion

Keith has previously discussed how qualifying offers are an important tool for taxpayers and practitioners. The qualifying offer in C1 Design was crucial, and allowed for the recovery of some fees. While the order and the underlying refund case is a victory for the taxpayer, it is not the complete victory that it sought. It is expensive to try tax cases. Assuming that the taxpayer is paying the balance of the attorney fees, that amount almost washes out the recovery of the late payment penalties that were the subject of the underlying refund case.

 

Happy (Belated) Thanksgiving!

The Taxatturky was spared again, and can continue providing quality tax advice for another year.IMG_0873

Procedure Grab Bag – Making A Grab for Attorney’s Fees and Civil Damages

Your clients love the idea, and always think the government should pay, but it isn’t that easy.  Below are a summary of a handful of cases highlighting many pitfalls, and a few helpful pointers, in recovering legal fees and civil damages from the government (sorry federal readers) that have come out over the last few months.

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3rd Party Rights

The Ninth Circuit, in US v. Optional Capital, Inc., held that a third party holding a lien on property could not obtain attorney’s fees for an in rem proceeding to determine its rights in real estate that had also been subject to government liens pursuant to the Civil Asset Forfeiture Reform Act, 28 USC 2465(b)(1)(A), or Section 7430.  The Court determined the 3rd party was not the prevailing party “in any civil proceeding to forfeit property,” as required by CAFRA.  The government had lost in a related hearing regarding the lien, but the 3rd party had “not pointed to any work it performed that was ‘useful’ or ‘necessary to secure’ victory against the Government,” so it was not the prevailing party.  It would seem, however, this leaves open the possibility of other 3rd parties prevailing, if meaningful work was done in the underlying case.  This case is a good reminder of another potential option under CAFRA in attempting to claim fees in certain collection matters.

As to Section 7430, the Court found, contrary to the 3rd party’s claims, it had not actually removed the government’s liens from the property, and therefore could not be considered the prevailing party, which is required under Section 7430 to obtain fees.

When You Are Rich Is Important

In Bryan S. Alterman Trust v. Comm’r, the Tax Court held that a trust could not qualify to recover litigation costs under Section 7430 because its net worth was over $2MM.  Section 7430 references 28 USC 2412(d)(2)(B), which states an individual must have under $2MM in net worth in order to recover litigation costs.  That is extended to trusts by Section 7430(c)(4)(D).  The taxpayer argued the eligibility requirement should be as of the time the deficiency notice was issued or the date the petition was filed.  That “reading” of the statute was found incorrect, as Section 7430(c)(4)(D)(i)(II) states the provision applies to a trust, “but shall be determined as of the last day of the taxable year involved in the proceeding.”  At that time, the trust had over $2MM in net worth, saving the IRS from potentially having to shell out capital.  And, that’s why I always keep my trust balances below $2MM…and right around zero dollars.

Key Questions: Are you the Taxpayer?  Did you Exhaust the Administrative Remedies?

The District Court for the Northern District of Illinois dismissed the government’s motion for summary judgment in Garlovsky v. United States on fees under Section 7433, but also gave clear indication that the claim is in danger.  In Garlovsky, the government sought collection on trust fund recovery penalties against an individual for his nursing home employer that allegedly failed to pay employment taxes.  Prior to that collection action, the individual died, and notices were sent to his surviving spouse (who apparently was some type of fiduciary and received his assets).  The taxpayer’s wife paid a portion, and then sued for a refund.  As to damages, the Court found that the taxpayer’s wife failed to make an administrative claim for civil damages before suing in the District Court, which is required under Section 7433.

In addition, although the surviving spouse received the collection notices, none were addressed to her and the Service had not attempted to collect from her.  Section 7433 states, “in connection with any collection of…tax…the [IRS] recklessly or intentionally, or by reason of negligence, disregards any provisions of this title…such taxpayer may bring a civil action…”  The Court found that the spouse was not “such taxpayer”, and likely did not have a claim.  Although I have not researched this matter, I would assume the estate of the decedent could bring this claim (unlike Section 7431, pertaining to claims for wrongful disclosure of tax information, which some courts have held dies with the taxpayer – see Garrity v. United States –a case I think I wrote up, but never actually posted).

Qualifying as a Qualified Offer

The 9th Circuit held that married taxpayers were not entitled to recover attorney’s fees under Section 7430 in Simpson v. Comm’r, where the taxpayer did not substantially prevail on its primary argument, even though they did prevail on an alternative argument.  In Simpson, the wife received a substantial recovery in an employment lawsuit.  The Simpsons only included a small portion as income, arguing it was workers comp proceeds (not much evidence of that).  The Tax Court held 90% was income.  This was upheld.  The 9th Circuit held that the taxpayer was clearly not successful on its primary claim.  They did raise an ancillary claim during litigation, which the IRS initially contested, but then conceded.  The Court held the Service was substantially justified in its position, as the matter was raised later in the process and was agreed to within a reasonable time.  Finally, the Court held that the taxpayer’s settlement offer did not qualify as a “qualified offer”, since the taxpayers indicated they could withdraw it at any time.  Qualified offers must remain open until the earliest of the date it is rejected, the date trial begins, or the 90th day after it is made.  Something to keep in mind when making an offer.

Making the Granite State Stronger – No Fees For FOIA

Granite seems pretty sturdy, but Citizens for a Strong New Hampshire are hoping for something even sturdier.  The District Court for the District of New Hampshire in Citizens for a Strong New Hampshire v. IRS has denied Strong New Hampshire’s request for attorney’s fees under 5 USC 552(a)(4)(E)(i) for fees incurred in bringing its FOIA case.  That USC section authorizes fees and litigation costs “reasonably incurred in any case under [FOIA] in which the complainant has substantially prevailed.”  The statute defines “substantially prevailing” as obtaining relief through “(I) a judicial order, or an enforceable written agreement or consent decree; or (II) a voluntary…change in position by the agency…”

Strong New Hampshire requested documents through a FOIA request regarding various New Hampshire politicians.  It took the IRS a long time to get back to Strong New Hampshire, and it withheld about half the applicable documents as exempt under FOIA.  Strong New Hampshire continued to move forward with the suit, and the Service moved for summary judgement arguing it complied.  Aspects remained outstanding, but the Court held that the Service had not improperly withheld the various documents.  The IRS did a second search, moved for summary judgement, and Strong New Hampshire did not contest.

The Court held that the voluntary subsequent search by the Service did not raise to the level of substantially prevailing by Strong New Hampshire.  As required by the statute, there was not a court order in favor of Strong New Hampshire, and the actions taken by the Service unilaterally in doing the second search was not sufficient to merit fees.

Private Debt Collection

I am not a fan of the idea of private debt collection and have posted about it before.  I mistakenly thought it died off as an idea.  The recent legislation, Protecting Americans from Tax Hikes Act of 2015, Pub. Law 114-113 (Dec. 18, 2015), reinstating private debt collectors came as a disappointment to me because my perception is that it will further degrade IRS collection rather than fix it. I would rather see Congress create more revenue officer and revenue representative jobs in local offices to move away from the remote collection so prevalent as a result of the shift in the last 30 years to Automated Collection Sites (ACS) and away from having individuals embedded in the same community as the taxpayer work on the delinquent account.

Adding non-IRS employees who will contact taxpayers will further confuse taxpayers already receiving calls from scam artist trying to shake them down in the name of the IRS and create other problems as well. The new legislation, however, does suggest that Congress knew the IRS would be reluctant to accept private debt collectors again after the failure of this program so recently.  So, Congress sought to address the problems up front by giving the IRS little leeway in how it will use private debt collectors and placing a carrot in front of the IRS if the private debt collection program works.

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Congress first authorized private debt collectors in 2004 with the passage of the American Jobs Creation Act of 2004, Pub. Law 108-357, § 881 (Oct. 22, 2004).  It codified private debt collection in IRC § 6306.  This initial use of private debt collectors came under heavy criticism from the National Taxpayer Advocate year after year.  As a result of the criticism from the NTA and others as well as a lack of success, Congress allowed the Service to abandon the use of private debt collectors though it did not strike Section 6306 from the Code.  The passage of another bill mandating private debt collectors so soon after the initial failure speaks to the strong interest of Congress in supplementing the IRS collection efforts while it stifles IRS hiring.  In bringing back the private debt collectors, the new legislation tightened the existing statute to provide greater statutory clarity concerning the types of cases on which the private debt collectors could, and could not, work.  With the initial passage of Section 6306 creating private debt collectors, Congress gave the Service more leeway to craft the program.  This time Congress sought to take tighter control over the reins.  Congress also created a new statute this time, Section 6307, to provide an incentive to the Service to make the private debt collection program work by providing that some of the funds collected by this program can go into a special account to allow the Service to hire additional collection personnel.

In the PATH legislation, Congress mandated that the Service implement the “new” private debt collection provisions within three months from passage of the legislation in December, 2015. So, we will see the first aspects of the program next month.   The basic concept places private debt collectors on those cases where the efforts of the IRS have failed or the Service lacks resources to pursue the debt.  The revised Section 6306 provides much detail on precisely the cases that should go to these private debt collectors.  The legislation at 6306(c)(1)(A)(i)-(iii) guides the IRS to a specific use of private debt collectors by providing a definition of “inactive tax receivable.” A debt due to the IRS receives this designation if it meets one of three criteria if:  1) “at any time after assessment, the Internal Revenue Service removes such receivable from the active inventory for lack of resources or inability to locate the taxpayer;” 2) “more than 1/3 of the period of applicable statute of limitations [on collection] has lapsed and such receivable has not been assigned for collection to any employee of the Internal Revenue Service;” or 3) ‘in the case of a receivable which has been assigned for collection, more than 365 days have passed without interaction with the taxpayer or a third party for purposes of furthering the collection of such receivable.’  The revised statute at 6306(d)(1)-(5) also provides a definition for certain tax receiveables not eligible for referral to the private debt collectors: 1) cases with a pending or active offer or installment agreement; 2) innocent spouse cases; 3) cases in which the taxpayer is deceased, under the age of 18, in a designated combat zone or a victim of identity theft; 4) cases in which the taxpayer is currently under examination, litigation, criminal investigation or levy or 5) cases in which the taxpayer has made a proper request to exercise their right to appeal .

The balance of the 2015 provisions relating to the private debt collectors provides various items designed to carry out the program. Congress needed to expand the disclosure laws to include certain disclosures to the private debt collectors and this required a change to Section 6103.  Congress required the Service to provide periodic reports on the progress of the program, and it allowed the President to exempt individuals in certain areas hit by a disaster.  The tight control Congress keeps on the private debt collection provisions in this second version coupled with the incentive program for the Service created in Section 6307 demonstrates the strong desire Congress has to see this program work and to both tie the hands of the Service in how it implements the program while putting a carrot in front of it if the program goes well.  The carrot comes in Section 6307 which allows the IRS to set up a special account from funds collected by the private debt collectors for use to create a special compliance personnel program.  Under this program the IRS can hire additional collection personnel with the money from the special account.   As I see it, the IRS can hire more revenue officers or ACS call site workers and is not restricted on how it decides to use this money.  Because the money is derived if private debt collection succeeds and goes away if it does not, the IRS must take care in hiring these workers since their source of funding could dry up.

Since 1954 when each state had a political appointee running the Service and the agency gave the appearance of having its employees influenced by the amount of money collected, Congress has resisted any efforts to provide incentives to the Service or to individual employees to collect more. In 1998 Congress even forbid the Service from keeping statistics on matters like how much an employee or a group collected or caused to be assessed.  Section 6307 appears to provide an incentive for the Service to want the private debt collection to succeed so it can have access to unappropriated funds with which to purchase more employees.  Between this program and the significant amount of unappropriated funds the Service now receives each year by charging fees for rulings and other services , Congress seems to be moving the IRS away from public service and integrity based on appropriated funds with no incentive to do anything but reach the correct result to one with monetary incentives for certain performance.  While the shift is small, this does not seem like a good trend.

Ninth Circuit Reverses Tax Court on Qualified Offer Case and Holds That a Concession is not a Settlement

In the Knudsen case decided last month, the Ninth Circuit reversed the Tax Court and determined that the qualified offer submitted by the taxpayer, on which the IRS failed to respond during the 90 period of the offer, formed the basis for determining that the position of the IRS in the case lacked substantial justification.  I previously blogged about the Tax Court case here.

The Knudsen issue concerns a loophole to the application of the qualified offer provisions the IRS tried to create in this case and others (see also Estate of Lippitz and Angle v. Comm’r.)  The IRS conceded that the petitioner did not owe the liability in Knudsen before the Tax Court reached a decision.  It then argued that the concession equated to a settlement of the case.  Regulation section 301.7430-7(e)(example 1) provides that a settlement negates a qualified offer.  The position of the IRS regarding concession, with which the Tax Court has agreed in the Knudsen case and others, has the effect of barring the beneficial presumption provided to taxpayers making a qualified offer which the IRS did not accept during the 90 day period of the offer.  If correct, the IRS position that its concession prior to a Tax Court decision on the merits, allows it to ignore the 90 day period and wait until just before trial (or even after trial) to see how the case goes before conceding a case and avoiding the consequences of the presumption afforded by the qualified offer with respect to attorney’s fees.  The 9th Circuit rejected the IRS argument that a concession equals a settlement on the facts presented here.  In doing so, it held for the taxpayer in a case argued on the taxpayer’s behalf by students at the Lewis and Clark Low Income Taxpayer Clinic.

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Background on Qualified Offers

While Congress created the opportunity for taxpayers to obtain attorney’s fees in cases in which they prevailed in 1982 (see Pub. L. 97-248, title II, section 292(a),) actually obtaining attorney’s fees proved almost impossible because the statute required the taxpayer to show that the IRS position in the case was not substantially justified.  (See The United States Tax Court – An Historical Analysis, 2d ed. At p. 502, et seq. for a discussion of the history of the provision.)  To address this concern with the statute, in 1998 Congress added subsection 7430(g) creating the qualified offer provisions.  A taxpayer making a qualified offer that the IRS does not accept during the 90 day qualified offer period and who prevails in the case achieving a result equal to or better than the amount offered, could overcome the substantially justified provision.  This qualified offer provision opens the attorney’s fee spigot in a way that did not exist prior to the statute’s amendment.

Using the qualified offer provision requires that petitioner give careful thought to the correct outcome of the case and tender an offer to the IRS during a specified period.  Section 7430(g)(2) requires that the offer must occur during a period “beginning on the date on which the first letter of proposed deficiency which allows the taxpayer an opportunity for administrative review of the Internal Revenue Service Office of Appeals is sent, and ending on the date which is 30 days before the date the case is first set for trial.”  I have yet to make a qualified offer to Appeals that caused Appeals to do anything special.  In fact, Appeals seems unconcerned about the 90 period.  Chief Counsel’s office does take note of qualified offers.  Their manual (see IRM 34.8.2.10) requires coordination with their National Office.  This requirement makes the person submitting the qualified offer slightly unpopular since it complicates handling of the case.

Sometimes, it appears to me that qualified offers may pass the 90 day time period while sitting in Appeals before they reach Counsel.  In a small case this can present Counsel with a choice to settle the case for the amount of the qualified offer or risk not only losing the case but incurring attorney’s fees that exceed the amount at issue in the case.  I have had Counsel concede the case immediately prior to trial in order to avoid attorney’s fees.  Based on the Tax Court’s interpretation of the statute, regulations and meaning of concession, such a tactic protects the IRS from attorney’s fees under the qualified offer provisions even though the 90 day period within which the IRS should have accepted the offer ran long before the concession.

The Loophole and the Knudesn Case

The success of this tactic causes me to label the late hour concession tactic as a loophole in the statute.  It defeats one of the major purposes of the qualified offer provision: to foster early resolution of cases.  This early resolution is vitally important when representing clients who may have thousands of dollars in refunds (often based on the earned income tax credit) held up pending resolution of a Tax Court matter. Through no fault of their own, many clients who are entitled to the EITC have been unable to prove eligibility during the correspondence audit process. Those individuals are forced to file a petition in Tax Court to resolve the case.

For those of us representing individuals claiming the EITC whose credit – sometimes equaling 33% or more of their annual income – remains frozen throughout the entire audit and litigation process, the hope that the qualified offer provisions would expedite the consideration of the case and the refund of the vitally important funds gets undercut by this tactic. In addition to the burden on the taxpayer, the late resolution of the case puts a burden on the clinic or pro bono attorney representing this taxpayer. While the representation occurs at no charge to the taxpayer, the clinic or pro bono attorney is entitled to compensation pursuant to IRC 7430 if the Tax Court awards attorney’s fees. These fees do not motivate clinics or pro bono attorneys but do compensate them for the time and effort of handling a case.

The Knudsen case, although coming out of a low income taxpayer clinic, did not involve the earned income tax credit but another common issue faced by low income taxpayers – the innocent spouse provisions.  Ms. Knudsen had a very sympathetic case.  The IRS agreed that she met the statutory qualifications for innocent spouse status; however, her case preceded the withdrawal by the IRS of its regulation requiring claimants under IRC 6105(f) to file their innocent spouse claim within two years after the first time the IRS took collection action. Because no factual dispute existed and the only question for the Tax Court involved the interpretation of the regulation concerning the timing of her request for relief, the parties submitted the case fully stipulated to the Court.  Long before the submission of the case fully stipulated, petitioner, through her counsel, had submitted a qualified offer.

The IRS did not accept her qualified offer within the period of the offer because of its litigation position.  Its success in three Circuits, despite its loss in the Tax Court in Lantz, gave the IRS reason to believe that its position regarding the regulation limiting the time for claiming relief under IRC 6015(f) not only met but exceeded the substantial justification for its litigating position.  (Despite the Circuit court victories, opponents of the regulation would argue that the regulation was wrong from the outset and the concession simply recognized that it never expressed the intention of Congress with respect to 6015(f) relief.  The concession of the issue merely recognized reality rather than conceding a matter on which it had prevailed in the courts.)  Of course, if the provision of the qualified offer knocked out the analysis of the basis for its position with a statutory determination on the issue, it faced attorney’s fees if it lost.

This was the situation when the IRS voluntarily reversed its position regarding the 6015(f) regulation that imposed a two year limitation on claiming innocent spouse status.  With the change of its position in the regulation, the IRS conceded the Knudsen case.  It had already agreed she met the statutory requirements for relief and denied relief solely on the basis of its position in the regulation regarding the timing of the request.  When the IRS conceded the case, the taxpayer prevailed in a result which exceeded her qualified offer which the IRS did not timely accept.  So, she sought attorney’s fees as the prevailing party in a matter in which the IRS lacked substantial justification because of the operation of the qualified offer provisions.

Knudsen: A Satisfactory Result But an Unsatisfying Approach

The Tax Court opinion simply equated concession to settlement and determined that Ms. Knudsen could not take advantage of the provision determining that the IRS lacked substantial justification.  It does not discuss how the IRS concession of an issue on which it had prevailed in three circuit courts might have influenced its decision.  Similarly, the 9th Circuit does not discuss the unusual nature of the basis for the concession here which could evoke sympathy for the IRS under the circumstances of this case at least with respect to attorney’s fees.  Rather, the 9th Circuit makes some broad statements about concessions not equating to settlements before continuing its discussion of the case in a manner that leaves me, at least, less satisfied than I was after reading the first parts of the opinion.

Had the 9th Circuit done a careful analysis of the differences between concession and settlement and had it addressed the purpose of the statute to foster early settlement of cases, I would have come away from the opinion more satisfied.  Instead, reading the opinion as a whole you come to a place not unlike the decision in Estate of Lippitz v. Comm’r  in which the Tax Court earlier granted attorney’s fees based on the qualified offer provisions after a concession by the IRS following a trial.  In other words, Knudsen, despite some broad language at the outset, still has the feel of a fact based determination rather than a legal one and that may mean the IRS will continue to litigate this issue.

Continued litigation of the issue ignores the real benefit that qualified offers present – quick resolution. The failure to quickly resolve Knudsen is understandable because it was part of a larger litigation issue; however, in almost all cases involving low income taxpayers the issues are not so complex that resolution cannot take place within the 90 period if the IRS will turn to the case during that period.

Conclusion

I hope I am wrong in thinking that this issue will continue. If it does, it is an unfortunate result because the position of the IRS, that it can concede a case and avoid the problem of lack of substantial justification, means low income taxpayers seeking frozen refunds (and others seeking an early end to litigation) must wait until the eve of trial or after trial in order to achieve a settlement Congress tried to foster at an early point in litigation.