There were three designated orders for the final week of February 2019, and all of them concerned Collection Due Process (CDP) cases. Two of the orders (Savanrola Editoriale Inc. here and McDonald here feature the time-honored determination that it is not an abuse of discretion for the IRS to sustain a collection action when the taxpayer refuses to provide financial information or otherwise take any part in CDP hearing. The orders are not particularly novel in that regard, but they do provide a good contrast to the third order where the Court actually finds against the IRS and remands to Appeals.
Since abuse of discretion is a fairly vague standard, even the easy cases can be useful. Savonrola involves a taxpayer that wanted to challenge the underlying tax liability leading to the notice of federal tax lien (NFTL). However, apart from requesting a CDP hearing (blaming a faulty 1099-Misc for the liability) and then petitioning the court after receiving the determination sustaining the NFTL, it does not appear that the taxpayer engaged in the process much at all. The order does not reference any content from the CDP hearing itself, and it is not clear if the taxpayer engaged in the one that was offered. At the very least, the taxpayer does not appear responsive to the Tax Court once the petition was filed -the case was on the verge of being dismissed for failure to respond to an order to show cause. Because the taxpayer made no showing (and raised no argument) that they should be able to argue the underlying liability under IRC 6330(c)(2)(B) the Court had an easy time disposing of the case.
In McDonald the taxpayer did engage a bit more, but still not enough to give themselves a chance of winning on review. Here, the taxpayer apparently wanted to enter an installment agreement but had been unable to (which can happen to the best of us). However, the taxpayer had a back-year tax return that was “rejected” (that is, not-processed) by the IRS which complicated matters. At the CDP hearing, IRS Appeals was understandably unwilling to set up an installment agreement without that return being properly filed. Appeals also requested a Form 433-A for the installment agreement -the reasonableness of that request depending a bit more on the terms of the installment agreement being proposed. In response, the taxpayer sent an unsigned 2015 return and a Form 433-A lacking supporting documentation. When the signature and supporting documents were not forthcoming after multiple requests, Appeals rejected the installment agreement request and issued a determination sustaining the levy. As can be guessed, based on the failure of filing compliance alone, the Court had very little trouble finding there to be no abuse of discretion.
One can read the frequent, easy cases of Savonrola and McDonald to mean simply that the taxpayer will lose if they don’t comply with IRS requests during CDP hearings. But there is a deeper lesson to be learned: the Court needs something to look at to see how IRS discretion was exercised. By failing to comply or otherwise engage with the IRS during the hearing, you are building a record for review that can only ask one question: was it a reasonable exercise of discretion for the IRS to request the information in the first place? Almost (but importantly not always) the Court will find requests for unfiled tax returns or financial statements are not unreasonable and, by consequence, there was no abuse of discretion for the IRS to sustain the collection action when the requests were not complied with.
The important difference is that taxpayers may succeed even without providing requested information if they have readily engaged in the process. By so doing, they create a record for the Court to review and, possibly, come to a determination that discretion, properly exercised, would not require the information. The most famous of these cases is Vinatieri v. C.I.R.. In Vinatieri, the taxpayer provided a Form 433-A and demonstrated serious financial hardship and medical issues during the CDP hearing, but acknowledged that she had unfiled tax returns. The financial hardship was obvious, as was the fact that it would be exacerbated by levy. The IRS policy (that back year returns must be filed before releasing a levy under IRC 6343(a)(1)(D)) was not so obvious, and blindly following it was an abuse of discretion. Ms. Vinatieri was, it should be remembered, a pro se low-income petitioner with serious health issues. She is the prototypical taxpayer that CDP is meant to protect before disastrous levies take place. Nonetheless, it is not clear she would have prevailed (especially not in a “record-rule” jurisdiction) had she not engaged with the IRS at the hearing.
CDP hearings can also help the more affluent (and represented) taxpayers on non-equitable grounds -and again, engaging is key. Sometimes, a taxpayer may not have to comply with an IRS request for information by adequately showing that the information is unnecessary -for instance, where updated financials are cumulative, because the real issue is a matter of law (See the earlier designated order from McCarthy v. C.I.R., here). When you turn the inquiry into a question of law (not always an easy, or possible task with low-income taxpayers) you change the Court’s rubric. And that is exactly what happens in the third and final designated order of the week
Tax Court to IRS: High School Math Rules Apply. Show Your Work or Face Remand. McCarthy v. C.I.R., Dkt. No. 21940-15L (here)
We’ve blogged briefly about Mr. McCarthy before. The case boils down to whether the petitioner or a trust is the real owner of two pieces of property. If petitioner owns it his collection potential should be upwardly adjusted and the IRS rejection of his Offer in Compromise (or partial pay installment plan) likely constitutes a reasonable exercise of discretion. The issue, then, is mostly legal: does the trust own the property, or is the trust merely the petitioner’s “nominee”?
When the issue before the Court is a question of law, the vagueness of “abuse of discretion” goes largely out the window. It is always an abuse of discretion to erroneously interpret the law at issue (See Swanson v. C.I.R., 121 T.C. 111 at 119 (2003)). McCarthy, however, involves a slightly different lesson: it isn’t necessarily that the IRS erroneously interpreted the law (thereby reaching the wrong determination). It is that the IRS didn’t sufficiently back up the determinations it did reach.
The IRS tried to determine whether the petitioner was the true “beneficial owner” of the properties in the trust by analyzing how the petitioner and trust actually treated the property. The first property at issue (the “Stratford” property) was rented out to a corporation (American Boiler) that was apparently controlled by the petitioner. American Boiler made rental payments to the trust for many years, though in apparently inconsistent amounts.
The IRS believed this string of relationships, peculiar circumstances, as well as the fact that there was no written lease agreement between American Boiler and the trust, adds up to nominee. But the Court sees some gaps between those circumstances and the ultimate conclusion. The Court characterized the argument as “inviting us to speculate that petitioner caused the Trust to use in some fashion for its own benefit the rental income it received from American Boiler.” In other words, the IRS hasn’t adequately shown how they get from point A to point B, and their failure to show their work is fatal. The Tax Court “will not indulge in such speculation.”
The IRS fares no better with the second piece of property (the “Charlestown” property). This time, the IRS inferences seem even more threadbare. The trust (with petitioner as trustee) purchased the Charlestown property. The IRS argues that it was “reasonable for [the Settlement Officer] to have inferred that the funds to purchase the Charlestown property must have come from petitioner.” Unfortunately, there are other beneficiaries (apart from petitioner) of the trust that may have led to other contributions to it, even aside from the aforementioned rental income the trust received. Accordingly, the Court finds no basis for the IRS determination that petitioner was the beneficial owner of the Charlestown property as well.
The point isn’t that the IRS was clearly wrong that the trust was not the nominee of the petitioner (it may very well be his nominee: he hasn’t exactly been a “good actor” in other tax matters –the first footnote of the order mentions his involvement in a criminal tax case). The point is that the IRS did not do its job in showing how they reasonably came to that conclusion apart from general inferences, which was the issue put before the Court. The taxpayer here may well be the polar opposite of Ms. Vinatieri: represented by counsel, likely affluent (at one time or another), and without the cleanest of hands. But like Vinatieri, (and unlike McDonald or Savonrola) they succeeded by engaging in the process and presenting a question (and record) the Court could reasonably rule in their favor on.