We welcome first-time guest blogger Maria Dooner to Procedurally Taxing. Maria is the Director of Tax Controversy Services at TaxFirm.com. She chairs the Board of Directors of Community Tax Aid in Washington D.C. and she is a co-author of the chapter, “Recovering Fees and Costs When a Taxpayer Prevails” in the forthcoming edition of Effectively Representing Your Client Before the IRS. Today Maria examines a recent Tax Court opinion denying costs to taxpayers who successfully appealed their CDP determination. Bryan Camp also wrote an excellent post on the case which you can find here. Christine
An award of reasonable administrative and litigation costs under section 7430 was designed to promote effective tax administration by preventing abusive actions and overreaching by the Internal Revenue Service (IRS). But to be effective, a taxpayer must actually recover costs when the government’s position was not substantially justified. A recent Tax Court decision not only continues to expose the challenges faced by taxpayers in recovering reasonable administrative and litigation costs from the IRS, but it also spotlights the need for potential Congressional action.
In Tung Dang and Hieu Pham Dang v. Commissioner, T.C. Memo. 2020-150 (Nov. 9, 2020), the Tax Court held that 1) the petitioners did not incur any reasonable administrative costs as defined by section 7430, and 2) the petitioners were not entitled to an award of reasonable litigation costs since the United States’ litigation position was substantially justified. The court focused almost exclusively on timing — it evaluated when the government’s position was or was not substantially justified and when costs were incurred. Previous PT blog posts have highlighted the difficulties in proving that the government’s position was not substantially justified (see here and here). This post primarily focuses on the challenges with recovering administrative costs due to the timeframe in which they are incurred.
Facts of Dang
Dang involved a tax collection case where a Revenue Officer denied the taxpayers’ request to levy their individual retirement account (IRA) to pay their outstanding tax liability – a request that would avoid the additional tax on early distributions and the potential sale of other assets. When declining the request, the Revenue Officer stated that the taxpayers had access to alternative sources of funds and she subsequently issued a notice of federal tax lien and notice of intent to levy. In response, the Dangs filed a request for a Collection Due Process (CDP) hearing, but the Settlement Officer sustained the IRS collection actions, stating that a levy is not a collection alternative considered by Appeals. (As an aside, the irony of this case cannot be overlooked – while the taxpayer is contesting the notice of intent to levy, the Appeals Office says “no” to the taxpayer’s specific levy request.)
After receiving an unfavorable notice of determination, the Dangs filed a petition to Tax Court where IRS Counsel conceded the issue in his answer, stating that a substitution of assets (via a levy) is a valid collection alternative, and the Appeals Office abused its discretion. Against the desires of the Dangs who wanted an order to levy their IRA, Special Trial Judge Armen remanded the case back to the Appeals Office to promptly hold another administrative hearing, correct its flawed reasoning and reconsider the taxpayers’ request to levy the IRA. Keith blogged about the remand order on PT here (the taxpayers unsuccessfully argued a remand was unnecessary).
After the Appeals Office concluded that the levy on the IRA was appropriate, and settlement was reached in Tax Court, the taxpayers filed a motion for approximately $13,000 in reasonable administrative costs and approximately $70,000 in litigation costs. The administrative costs claimed by the Dangs included the time spent preparing and participating in the CDP hearing. The litigation costs claimed by the Dangs included all the work that was performed after receiving the Notice of Determination from the Appeals Office. This included time spent preparing the Tax Court petition and work performed while the taxpayers were in Tax Court, including the time spent on the case during the supplemental CDP hearing when it was remanded back to the Appeals Office.
Was the government’s position substantially justified, and when were costs incurred?
To successfully recover costs, the taxpayer must have exhausted administrative remedies with the IRS, have not unreasonably protracted the proceedings, have claimed reasonable costs, and have ultimately prevailed (as well as have satisfied a net worth requirement). Under section 7430(c)(4)(B)(i), a taxpayer cannot be a prevailing party if the United States was substantially justified in their position. When determining whether the government was substantially justified in its position in Dang, Judge Marvel applied a bifurcated analysis. This involved determining whether the government’s position was substantially justified in 1) its notice of determination in the administrative proceeding, and 2) its answer in the judicial proceeding. However, before the first question was evaluated, Judge Marvel questioned whether any permissible costs were in fact incurred during the administrative proceeding.
Pursuant to section 7430(c)(2), administrative costs are those incurred by the taxpayer on or after the earliest of: (1) the date of the receipt by the taxpayer of the notice of decision by the IRS Independent Office of Appeals, (2) the date of the notice of deficiency, or (3) the date of the first letter of proposed deficiency that allows the taxpayer to appeal to the IRS Independent Office of Appeals. Because Dang involved a CDP hearing, the only relevant date was the date the taxpayers received the Notice of Determination, which is essentially the notice of decision referenced in the law. So, on or after the notice of determination, the taxpayers could recover any costs incurred from that point forward within an administrative proceeding.
Unfortunately, the notice of determination is probably the worst date to start accruing administrative costs as it concludes a collection case at the administrative level. (The ideal date from a taxpayer’s perspective would be the date the Dangs received a right to a CDP hearing.) But upon receipt of the notice of determination, the Dangs have no move to make in which they could possibly recover any administrative costs. Their only task at hand is to prepare for litigation by reviewing the notice of determination and filing a petition to the Tax Court — time that the Dangs appropriately classified as litigation costs.
Since there were no “administrative costs” (within the scope of the statute) to be awarded, the Tax Court solely evaluated whether the government’s position was substantially justified in the litigation proceeding, relying on Huffman v. Commissioner, 978 F.2d 1148 (1992). Because the IRS promptly conceded its error and moved to remand the case back to the Appeals Office, Judge Marvel found that the IRS’s position was substantially justified. Therefore, no litigation costs could be awarded to the Dangs.
Did the decision to remand create additional administrative costs that could be awarded?
While this case is exceptional in more ways than one, additional costs associated with a supplemental CDP hearing (via a remand) add another twist. Bryan Camp suggests in his post that these costs were incurred after the notice of determination and as part of an administrative proceeding, so there could be an argument that there are administrative costs to be awarded.
This is an interesting point that was not addressed by the Tax Court, which was likely due to the fact these costs were classified as litigation costs by the Dangs. In the Dang case, the supplemental CDP Hearing was held at the direction of the Tax Court, and the hearing was very much connected to the court proceeding, which ultimately concluded the case. (In his order to remand the case back to the Appeals Office, Special Trial Judge Armen still retained jurisdiction over the case.) Thus, it appears that the time spent preparing, traveling, and participating in the remanded appeals hearing was appropriately classified as litigation costs under section 7430(c)(1)(b)(iii).
Why does the definition of “administrative costs” in section 7430 fail to encompass most costs incurred within administrative collection due process proceedings?
Judge Marvel did not analyze whether the government’s position was or was not substantially justified in the administrative proceeding, but we can assume that the position was not substantially justified. (The IRS went against published guidance (i.e. Treas. Reg. 301.6330-1(e)(3)), and this was recognized by IRS Counsel who immediately conceded the issue as well as Special Trial Judge Armen who remanded the case back to the Appeals Office for a do-over.)The question then becomes: why should the Dangs be unable to recover costs for time spent preparing and participating in the original CDP Hearing, which clearly went wrong and did not serve its intended purpose?
As explained above, Judge Marvel’s decision hinges on the definition of “administrative costs” in section 7430(c)(2), which incorporates a timing rule that effectively excludes CDP hearings from consideration. But Regulation § 301.7430-3(a)(4) appears to go even further, providing that a CDP hearing is not an administrative proceeding for which reasonable administrative costs can be recovered. In their brief, the Dangs argued that this regulation should be disregarded as inconsistent with the statute. The Dangs note, “there is simply no statutory authority for eliminating CDP hearings from the cost recovery regimen.” In their brief, the Dangs emphasize the very first sentence of section 7430, which states that the prevailing party may be awarded reasonable administrative costs in any administrative proceeding in connection with the collection of any tax. They also explain how Regulation § 301.7430-3(a)(4), which precludes most collection actions, particularly a CDP hearing (“the quintessential collection administrative hearing”), from the definition of an administrative proceeding for purposes of section 7430, does not align with the first sentence of section 7430. But despite this being true, it does not change the outcome of the case. Unfortunately, it is the dates that triggered these costs, listed in section 7430(c)(2), that preclude and will continue to preclude the award of administrative costs in most CDP hearings. The dispute over the regulation is a red herring.
Why then did Congress enact a seemingly contradictory statute? An interesting explanation for these dates lies within a small footnote in the Tax Court opinion, indicating that it was Congressional intent to preclude an award for administrative costs arising from a collection action:
In 1988, when Congress amended sec. 7430 to include recovery for administrative costs in addition to litigation costs, the legislative history of the amendment acknowledged that the dates triggering costs precluded an award for administrative costs arising from a collection action. See H.R. Conf. Rept. No. 100-1104, at 226 (1988), 1988-3 C.B. 473, 716 (“Thus, with respect to a collection action, only reasonable litigation costs are recoverable under * * * [sec. 7430].”).
Ironically, a deeper dive into the Technical and Miscellaneous Revenue Act of 1988 shows that its amendment to section 7430 did not even facilitate the recovery of administrative costs for most taxpayers in deficiency proceedings. As passed, this law classified administrative costs as those incurred on or after the earlier of the date of receipt of the notice of the decision of the Appeals Office or the date of the notice of deficiency. Though the Senate bill included a third date, the date of notice of proposed deficiency (often known as the “30-day letter” into the Appeals Office), this was not incorporated into the 1988 Act. Therefore, the 1988 Act added the words “administrative costs” to section 7430, but it failed to provide meaningful impact to taxpayers pursuing administrative costs in deficiency proceedings. By not providing for the effective recovery of administrative costs in proceedings involving both the assessment and collection of tax, the inclusion of “administrative costs” was in many ways meaningless.
It was not until the passage of the Internal Revenue Service Restructuring and Reform Act of 1998 that Congress approved the award of administrative costs incurred on or after the date of a notice of proposed deficiency. After that, taxpayers were able to recover administrative costs from the moment they received the notice of proposed deficiency and onward. Simultaneously, the 1998 Act created taxpayers’ rights to a CDP hearing — an independent review of a notice of intent to levy and notice of federal tax lien, culminating in a notice of determination and the right to judicial review.
Although we do not know the exact intent of Congress regarding the award of administrative costs in CDP hearings, the legislative history suggests that Congress either lacked an understanding of when these costs were incurred or was not fully committed to awarding them. For example, the fact that Congress did not facilitate the recovery of administrative costs associated with a collection proceeding in the 1998 law could have been an oversight when they were simultaneously creating a collection hearing that did not yet exist. Or maybe more likely, Congress did not understand the dates that triggered these costs. Remember, it took them approximately 10 years, after the law was amended to award administrative costs, to finally incorporate a provision that facilitated the recovery of these costs in deficiency proceedings.
This leads to what may be the main significance of Dang… a successful recovery of administrative costs by taxpayers requires a better understanding of when these costs are actually incurred and a more serious commitment to award them by Congress. The resources exerted in the Dang case where volunteer attorneys spent hours providing financial information, preparing for a CDP hearing, filing motions and briefs, preparing for a second CDP hearing, etc. (all to get back to an answer originally granted by the first Revenue Officer who approved the levy but was replaced by a second Revenue Officer who did not) show the importance of passing a law that allows for the effective recovery of costs and fees when the administrative process goes wrong.
As a start, Congress could incorporate “costs incurred on or after the date of receipt by the taxpayer of a right to a CDP hearing” into section 7430(c)(2) for the sake of theDangs and thousands of taxpayers in collection cases. By making section 7430 more meaningful, Congress will make it more important for the IRS to follow published guidance in administrative collection due process hearings and will help the IRS achieve its mission in providing top quality service. Ultimately, the purpose of these awards is not to penalize but rather enhance effective tax administration, and to do this, more taxpayers must actually recover costs when the IRS errs.