Information from Administrative Practice Programming at the May ABA Tax Section Meeting

At each ABA Tax Section meeting certain committees have programing that directly impacts tax procedure, and we try to cover those committees.  At the May meeting none of the regular bloggers attended the Administrative Practice Committee meeting – usually one of the critical committee meetings for tax procedure information – but Abbey Garber and Bibiana Cruz of Holland & Knight agreed to cover this meeting.  We welcome them as first time guest bloggers.  Abbey worked for Chief Counsel in the Dallas office for many years (where I first met him) before retiring and moving to the firm.  Bibiana is an associate in the firm’s Miami office. You can view the slides from the meeting here.

The discussion of the information coming from committee meetings serves as a good reminder that the next ABA Tax Section meeting is coming up next month in Dallas.  The preliminary program is here. You can register and get other information about the meeting here.  Keith

On May 13, 2022, as part of the ABA’s Tax Section Meeting in Washington D.C., the Administrative Practice Committee invited Holly Paz, IRS Deputy Commissioner of the Large, Business and International Division (LB&I), Scott Irick, IRS Director of Small Business / Self-Employed (SB/SE) Examination Division, Abbey Garber, Partner at Holland & Knight’s Tax Controversy and Litigation Group, and Henry Cheng, Associate at DLA Piper’s Tax Controversy and Litigation Group to discuss Exam’s return to office, innovations and challenges encountered during COVID, and what Exam is currently focusing on. Paige Braddy, from Skadden Arps, moderated the panel, titled IRS Exam –Reflections on Two Years of COVID.

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The IRS has completed its return to office transition after more than two years of COVID. As of June 25th, normal in-person operations have resumed. However, the IRS continues to be flexible in certain aspects such as digital/photograph signatures for some purposes, which will be accepted until October 31, 2023. In addition, other innovative tools such as virtual reading rooms and video conferencing through Microsoft Teams are now being utilized. Also, the fax machine option is receiving an upgrade as some web-based upload tools are being introduced.

During the chat, the panelists discussed the new IRS Office of Chief Counsel Memorandum 20214101F which sets forth the requirements for a taxpayer to claim an I.R.C. Section 41 research credit refund on an amended return. In summary, these requirements include: (i) the identification of all the business components that relate to the claim, (ii) identification for each business component of the activities performed, the individuals who performed such activities and the information each individual sought to discover, and (iii) providing the total qualified employee wage expenses, supply expenses and contract research expenses. The memo also provides a 45-day period (increase from the prior 30-day period) to perfect a claim for refund prior to a final determination. According to the officials, at the moment, a low volume of submissions have been received, but they expect to evaluate the process further once sufficient number of claims come in.

The group also discussed the continuing validity of Rev. Rul. 94-69. Rev. Rul. 94-69 allows large corporate taxpayers who are under continuous audit to make affirmative disclosures at the start of the audit with the practical effect of informally “amending” a return without having to file all of the required paperwork. The IRS has published a new draft form (Form 15307, Post-Filing Disclosures for Specified Large Business Taxpayers) in an effort to standardize submissions. Although this process is still being examined, the idea is for certain large taxpayers to have a clear view of what information needs to be provided and that there is consistency among taxpayers as to the information being submitted. The IRS is evaluating whether the population of eligible taxpayers will be changed.

LB&I has made some changes related to the assertion of the Economic Substance Doctrine and related penalties. As of April 22, 2022, the level of approval required to assert the application of this doctrine and its related penalty has changed: executive approval is no longer required to raise this argument and to assert the economic substance penalties. This, however, does not remove the requirement that the penalties must be approved in writing by the immediate supervisor of the person who initially determines the penalty.

The application procedure to the Compliance Assurance Process (CAP) also has undergone some changes. These include: (i) for 2022 CAP years “two filed” open returns are permitted, (ii) audited financial statements in accordance with GAAP must be provided, and (iii) new applicants will be required to complete the Tax Control Framework Questionnaire. On September 15, 2022, the IRS announced the opening of the application period for the 2023 Compliance Assurance Process (CAP) program. The application period runs from September 15 to November 15, 2022.

Partnerships are being closely monitored by the IRS and audits under the new BBA centralized partnership audit regime are ongoing. According to the officials, the IRS is looking to increase its coverage by bringing in new resources and increasing agent training in partnership exams. The IRS officials cautioned that, regardless of taxpayers having elected out of the BBA, an audit could be underway.

The Fast Track Appeals Process is also under review. Fast Track, a voluntary mediation program and an option for most disputes at Exam, is an alternative process where a mediator seeks to facilitate settlement discussions making it a shorter, and more flexible and cost-effective process. According to the IRS, they are looking to improve Fast Track by increasing agent training and by using metrics to measure progress and identify areas for improvement.  

The IRS is aware of its challenges and taxpayers’ struggles in their communications with the agency. It is focused on tackling the long processing delays and improving taxpayers’ overall experience with the IRS. To make this happen, the IRS is looking to hire 400 new agents and increase training for existing ones. It is also updating its technology and communication platforms. Leadership changes also have occurred, with the recent announcement of Lia Colbert as Commissioner of SB/SE and Maha Williams as Acting Deputy Commissioner for SB/SE Exam.  Darren Guillot will continue to serve as Deputy Commissioner for Collection. They are hopeful that these changes, along with increased resources, have a positive outcome for taxpayers and practitioners.    

Some Interesting Data from this Year’s TIGTA Federal Tax Lien Filing Review

In the Restructuring and Reform Act of 1998 Congress required the Treasury Inspector General for Tax Administration (TIGTA) to conduct annual reviews of certain IRS activities.  The law requires TIGTA to annually determine if the notices of federal tax lien (NFTL) the IRS files comply with the requirements of IRC 6320.  This year TIGTA had some findings about the IRS lien filing that might be of interest.

I will start with the one TIGTA mentioned last which concerns the liens the IRS chose not to file.  The IRS has pegged $10,000 in tax debt as the point at which it will generally file an NFTL.  I think that dollar amount is too low and that the IRS should generally not file the NFTL until the amount rises to about $25,000 or more. If the taxpayer owes $10,000 or more the general guidance from the IRM would cause someone at the IRS to trigger the filing of the NFTL unless there is a decision not to do so. 

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It could also just be that NFTL filings are down in the year covered by the report because of the pandemic.  Almost certainly the pandemic plays a role.  Here is a chart showing the number of NFTLs filed in the past five years: 

TIGTA created a detailed chart showing the amount owed for the 1,337,932 individual and business taxpayers who owed more than $10,000 at the time of their review. 

TIGTA also did a cross reference to cases with balances due where a Form 1098 for mortgage interest was reported since real property ownership is generally where the IRS gets the biggest bang for its buck with the NFTL. 

The failure to file the NFTL in these cases, particularly the ones over $100,000, suggest the IRS may lose an easy opportunity to collect on its outstanding debt.  The cost of filing and servicing the NFTL is low compared to the possible return on the investment in cases where it is known that the taxpayer owns real property.

Because of the low number of revenue officers, most cases with liabilities below $75,000 or $100,000 are handled by the Automated Call Sites (ACS) and not by Revenue Officers (RO).  This means that decisions on many NFTL filings are made by people with less collection experience.  It appears that the IRS is failing to make a decision and failing to file the NFTL.  The failure to file the NFTL may be good for the first category of cases in the chart.  Perhaps this reflects a de facto decision by the IRS that it’s not worth the time and effort to try to file a lien but it could also be bad for the other cases in the chart where there are a decent number of high dollar delinquent accounts where the IRS does not perfect its priority by filing the NFTL.  I cannot imagine why the IRS would not file the NFTL on almost all of the 3,000 cases over a million dollars in delinquent debt.

In addition to the finding that the IRS is neglecting to file the NFTL, the report made a few other findings of significance.  When the IRS files an NFTL for the first time in a tax year, it must provide the taxpayer with Collection Due Process (CDP) rights.  Unlike the notice sent with respect to levies, the notice in lien cases is sent after the filing of the NFTL in order to keep taxpayers from selling or encumbering property before the IRS files the NFTL. TIGTA found that the Collection failed to send the CDP notice to the correct address in 5 of 34 cases in which the notice went undelivered.  This makes it hard for taxpayers to contest the filing of the NFTL.

In addition to failing to send the CDP notice correctly to taxpayers, TIGTA found that the IRS did not send the notice to the taxpayer’s representative in six of 57 sample cases – about 11% of the time.  The failure to notify the representative severely compromises a taxpayer’s ability to request a CDP hearing within the short 30-day time period provided in the statute.  It will be interesting to see how this might play out after Boechler when taxpayers request additional time because of the failure of the representative to receive notification.

The study found that the IRS fails to do the appropriate research to find the taxpayer’s current address and to find information regarding taxpayer’s representatives. These should not be difficult things to fix but these should not be items that need fixing at this point.

In cases where the IRS fails to send the NFTL notice to the taxpayer’s last known address the taxpayer’s ability to get a CDP hearing would be impacted but the validity of the notice would not be impacted.  I know of no cases striking down the notice as invalid based on a failure of notice to the taxpayer after the filing of the NFTL. 

Once the bad mailing came to light the taxpayer should receive another letter which would trigger CDP rights or should be able to come into the CDP process more than 30 days after the bad mailing.  When I say bad mailing I mean a mailing where the notice to the taxpayer of the filing of the NFTL was not sent to the taxpayer’s last known address.

Some of the cases in which the taxpayer did not receive the notice in the TIGTA report may have been situations in which the IRS would win on whether the notice was sent to the taxpayer’s last known address.  TIGTA did not get into the weeds on the validity of the notice from that perspective.

If the IRS sent the letter to the taxpayer’s last known address but the taxpayer did not receive the letter, there should be no question about the validity of the NFTL.  The ability of the taxpayer in that situation to obtain a CDP hearing might depend on where the equitable tolling case law in CDP cases goes.  TIGTA rightly points out that maybe the IRS should try to reach out to taxpayers when it learns that their “last known address” was not in fact their address because the correspondence was returned.  Deciding how far to go in these situations has long been a challenge for the IRS.

Maybe the report is good news for those taxpayers who have not had a NFTL filed against them.  If they are lucky, the statute of limitations on collection will run before the NFTL is filed or the IRS takes other collection action.

Fifth Circuit Upholds Constitutionality of Passport Revocation Statute

Franklin v US is the latest case considering the constitutionality of the IRS and State Department power to restrict international travel when a taxpayer has seriously delinquent tax debt, i.e., legally enforceable federal tax debt totaling more than $55,000 (including interest and penalties).

Franklin failed to report his beneficial ownership of a foreign trust, triggering hefty penalties under Section 6676.  Following assessment and nonpayment, the IRS certified to the Department of State that Franklin had a “seriously delinquent tax debt.” That led the State Department to revoke Franklin’s passport.

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I note but will not discuss that in addition to his claim that the passport revocation scheme violated his 5th Amendment due process rights, Franklin raised other challenges to the 6676 penalty. The Fifth Circuit held that those challenges ran afoul of the Anti-Injunction Act.

The main part of the Franklin opinion addresses the claim that the government’s power to restrict travel violated Franklin’s substantive due process rights. Substantive due process “protects individual liberty against ‘certain government actions regardless of the fairness of the procedures used to implement them.’” Collins v. City of Harker Heights, 503 U.S. 115, 125 (1992) (quoting Daniels v. Williams, 474 U.S. 327, 331 (1986)).

The Fifth Circuit disagreed with Franklin. In so doing, it parsed a number of Supreme Court cases that have explored whether there is a fundamental right to international travel. That inquiry is important, because if government action impinges on a fundamental right, the court applies “strict scrutiny” to the legislation, and governmental restriction of a fundamental right must be “narrowly tailored to serve a compelling state interest.” Washington v. Glucksberg, 521 U.S. 702, 720–21 (1997).

In the absence of a fundamental right, typically the court applies a rational basis test, and the “restriction at issue survives as long as it is ‘rationally related to a legitimate government interest.’” quoting  Reyes v. N. Tex. Tollway Auth., 861 F.3d 558, 561 (5th Cir. 2017). The Fifth Circuit held that while there is a fundamental right to interstate travel there is no similar fundamental right to international travel. In so doing, the opinion discusses how courts view whether a right is fundamental:

[W]hether that right is “‘deeply rooted in this Nation’s history and tradition’ . . . and ‘implicit in the concept of ordered liberty,’ such that ‘neither liberty nor justice would exist if [the right was] sacrificed.’” Glucksberg, 521 U.S. at 721 (first quoting Moore v. City of E. Cleveland, 431 U.S. 494, 503 (1977), then quoting Palko v. Connecticut, 302 U.S. 319, 325, 326 (1937)). The Supreme Court has cautioned that, because declaring a right as fundamental “to a great extent . . . place[s] the matter outside the arena of public debate and legislative action,” courts should “exercise the utmost care whenever [they] are asked to break new ground in this field.” Id. at 720 (quoting Collins, 503 U.S. at 125).

For sure there is lots of room for debate on whether something is deeply rooted in history and tradition or implicit in the concept of ordered liberty. And the Fifth Circuit acknowledged some earlier Supreme Court opinions that framed international travel as a fundamental right, though it pointed to later opinions that distinguished travel within the states as compared to travel to differing countries. For example in Haig v Agee, the Supreme Court made that distinction when considering the revocation of the passport of an ex CIA agent who threatened to reveal secrets:

“[T]he freedom to travel outside the United States must be distinguished from the right to travel within the United States.” 453 U.S. 280, 306 (1981).

The Fifth Circuit acknowledged that other opinions that have considered the constitutionality of Section 7345 have applied an intermediate type scrutiny, recognizing the importance of the right to international travel (Keith discussed one of those cases, the 10th Circuit’s Maehr v US, in Passport Revocation Cases Part 2). Intermediate scrutiny requires that the challenged restriction “must serve important governmental objectives and must be substantially related to achievement of those objectives.” Craig v. Boren, 429 U.S. 190, 197 (1976).

In acknowledging the importance of all travel the opinion states that “Franklin is correct in his assertion that the right to international travel is not a new creation unmoored from our past, but instead can be traced through the ages from Magna Carta to Blackstone to the Declaration of Independence to the modern Universal Declaration of Human Rights.”

While declining to decide whether it should be required to apply rational basis or intermediate level scrutiny, the opinion stated that even under intermediate scrutiny it would find the scheme constitutional. The money paragraph in the opinion essentially ties the revocation powers to the essential government interest in collecting revenue:

Even under the higher standard of intermediate scrutiny, the FAST Act’s passport-revocation scheme is constitutional. The government’s interest in collecting taxes, which animates the FAST Act’s passport-revocation scheme, is undoubtedly an important one. See, e.g., Hernandez v. Comm’r, 490 U.S. 680, 699 (1989) (“[E]ven a substantial burden would be justified by the ‘broad public interest in maintaining a sound tax system’” (quoting United States v. Lee, 455 U.S. 252, 260 (1982))); Flora, 362 U.S. at 154 (“It is essential to the honor and orderly conduct of the government that its taxes should be promptly paid[.]”). The passport-revocation scheme is also clearly connected to that goal: delinquent taxpayers will be well-incentivized to pay the government what it is owed to secure return of their passports, and those same taxpayers will find it much more difficult to squirrel away assets in other countries if they are effectively not allowed to legally leave the country.  (emphasis added).

The opinion notes as well that the passport revocation statute targets larger tax debtors and thus “does not sweep beyond what is necessary to achieve Congress’s goal of trying to recoup the $5.8 billion or more in delinquent taxes owed to the government.”

The opinion continues on the theme that the legislation is targeted:

[W]hat Congress provided was an arrow, not a bazooka. Its chosen tool is carefully aimed at the problem, not fired indiscriminately with grave risk of collateral damage to the rights of those not covered by the scheme.

Conclusion

This is the third circuit to uphold the constitutionality of the passport revocation statute, and while it acknowledges that international travel is not to be taken lightly, the opinion is a major government victory for an important collateral tool to collect from taxpayers who have failed to pay sizable liabilities.

Out of Time? APA Challenges to Old Tax Guidance and the Six-Year Default Limitations Period

We welcome back previous guest blogger Susan C. Morse, who is the Angus G. Wynne Sr. Professor in Civil Jurisprudence and Associate Dean for Academic Affairs at the University of Texas at Austin School of Law.

Is it ever too late to raise an administrative procedure challenge to an old tax regulation?

Consider the pair of cases that has produced a circuit split between the Sixth and the Eleventh Circuits over the adequacy of notice-and-comment for a conservation easement final regulation. (Prior Procedurally Taxing coverage here and here.) The Sixth Circuit held in Oakbrook that the notice-and-comment process was sufficient. In contrast, the Eleventh Circuit concluded in Hewitt that Treasury “violated the Administrative Procedure Act’s requirements” when it promulgated the regulation and that therefore the IRS Commissioner’s application of the regulation was “invalid.” But neither court addressed the question of time. The regulation was promulgated in 1986 – decades before any of the facts arose in either case.

Does time ever limit taxpayers’ ability to raise administrative procedure challenges long after the promulgation of a regulation? Consider 28 U.S.C. § 2401(a), the default limitations period for suits against the federal government. It provides that “every civil action commenced against the United States shall be barred unless the complaint is filed within six years after the right of action first accrues.”

The limitations period analysis turns on when the “right of action” to raise an administrative procedure challenge to a regulation “first accrues.” For instance, in Oakbrook and Hewitt, if this right accrued in 1986, when Treasury promulgated the regulation at issue, then the taxpayers’ claims should have been time-barred. On this theory, the taxpayers were allowed to litigate because the government did not raise 28 U.S.C. § 2401(a) as a defense. (The government can waive the defense, as it’s not jurisdictional.) If the government had raised the six-year limitations period defense, the Oakbrook or Hewitt taxpayer would have had to argue that the right of action first accrued later, when the regulation was applied to the taxpayer’s case, or that an exception to the limitations period should apply.

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Now the government has begun to raise the six-year limitations period defense, first in July 2022, in the Govig case, pending in the federal district court in Arizona. Govig involves Notice 2007-83, which was issued nine years before penalties were first proposed on Govig for the 2016 tax year, relating to the employee welfare benefit arrangement established by the taxpayer in 2015. In Govig, the taxpayer claims that the Notice is invalid because it was issued without notice and comment, and relies on the Sixth Circuit’s decision in Mann Construction. In Mann Construction, though, the government did not raise the six-year limitations period defense.

More than half the Courts of Appeal – the Second, Fourth, Fifth, Sixth, Ninth, Eleventh, D.C., and Federal Circuits – have accepted that for administrative procedure claims, the default six-year limitations period begins to run when the challenged regulation or guidance issues, in other words at the time of final agency action. This limitations period statute exists against the background of sovereign immunity, meaning that it is an exercise of Congressional power to specify on what terms the federal government may be sued. In contrast, for certain other claims, such as claims that the agency exceeded its statutory authority, the limitations period begins to run when the regulation or guidance is applied. This is called the Wind River doctrine after a key 1991 Ninth Circuit case. The Wind River doctrine would say that the limitations period for an administrative procedure challenge to Notice 2007-83 began to run in 2007 and expired in 2013, before any relevant facts arose in the Govig case.

It may seem an awkward reading to suggest that a “right of action first accrues” with the earlier issuance of a Notice, especially when the specific controversy between the taxpayer and the government arises from later enforcement proceedings. And yet that is what the cases hold. As an example, consider Sai Kwan Wong, a 2009 Second Circuit case where the plaintiff sought to challenge a Medicaid rule that treated social security disability income as an amount that offsets Medicaid funding of nursing home care, even if that income was deposited into a special needs trust. The Department of Health and Human Services had promulgated a rule providing this offset treatment in 1980, apparently without using notice and comment. The plaintiff did not have standing until 2006, when his legal guardian began to direct the plaintiff’s disability income to a special needs trust, thus raising the question of whether the offset rule would apply. The Second Circuit held that the six-year limitation period began to run in 1980, when the guidance issued, and not in 2006, when the plaintiff had standing. It then barred the plaintiff’s administrative procedure claim.

The theory that underpins cases like Sai Kwan Wong is articulated in Shiny Rock, a 1990 Ninth Circuit case that preceded Wind River by one year. There, the court explained that any injury “was that incurred by all persons .. in 1964” when the Bureau of Land Management issued a public land order – not in 1979, when Bureau applied the order to deny the plaintiff’s mineral patent application. The Shiny Rock court suggests that the rights that are vindicated by an administrative procedure challenge are the general public rights to participate in the administrative procedure process. A later-accrual approach, added the Shiny Rock court, “would virtually nullify the statute of limitations,” since it would always be possible for the old administrative order to applied later, to a new plaintiff who had later gained standing. Viewed this way, the case law consensus that the limitations period begins to accrue when a regulation is promulgated makes sense.

An alternative reading of 28 U.S.C. § 2401(a) might be that a particular plaintiff’s right of action cannot accrue until the plaintiff has standing. This reading is grounded in a private law understanding of the statutory provision, which envisions the government as party to a contract or tort action that arises from a specific transaction or interaction between the government and a plaintiff. But administrative procedure violations are not like these private law causes of action. They arise not from a specific interaction between government and plaintiff, but rather from the alleged failure of a process that is supposed to serve the general public function of producing better administrative law.

Thus, in Govig, if the District of Arizona follows Ninth Circuit precedent, it should conclude that the administrative procedure challenge to Notice 2007-83 is time-barred – unless, of course, the Govig plaintiffs can persuade the court that an exception to the limitations period applies. There is little in the facts of Govig that would support an equitable tolling or equitable estoppel argument. For instance, the government did not hide information or delay enforcement in order to wait out the limitations period. Instead, the facts of the case did not arise until after the limitations period had expired.

An issue that may arise in Govig relates to intervening case law. This is because the Govig plaintiff arguably relies on CIC Services, a 2021 Supreme Court case that held that some facial or pre-enforcement challenges are permitted in tax, despite the Anti-Injunction Act. (Prior Procedurally Taxing coverage here, here, and here).Historically, intervening case law has restarted the 28 U.S.C. § 2401(a) limitations period when a case has only prospective effect – but not if the case has (as is typical) retroactive effect. Plus, more recent Supreme Court precedent emphasizes that its applications of federal law “must be given full retroactive effect …as to all events, regardless of whether such events predate or postdate the announcement of the rule.” The intervening case law argument seems unlikely to offer the Govig plaintiff an exception to the time limitation of 28 U.S.C. § 2401(a).

The Govig case is one to watch. If the Arizona federal district court follows prevailing case law, it will likely allow the government’s limitations period defense and time bar the plaintiff’s administrative procedure claim. The availability of such time bars would reshape the landscape of administrative procedure in tax by putting APA claims on the clock and replacing the assumption that the government will waive the 28 U.S.C. § 2401(a) limitations period defense.

For further reading, if of interest: I have posted a preliminary draft here with additional analysis of this limitations period issue.

The “What” and “When” of IRC 6751(b)

In Kroner v. Commissioner, No. 20-13902 (11th Cir. 2022) the court reverses the decision of the Tax Court concerning the timing of the supervisor’s approval of a penalty agreeing with the Ninth Circuit’s decision in Laidlaw’s Harley Davidson Sales, Inc. v. Comm’r, 29 F.4th 1066, 1071 (9th Cir. 2022), blogged here, and setting up a direct conflict with the Second Circuit in Chai v. Commissioner, 851 F.3d 190 (2d Cir. 2017) initially blogged here.  Maybe 6751(b) has a ticket to the Supreme Court.  This is the second big victory for the IRS in a row at the circuit level after it has mostly struck out at the Tax Court on timing issues. 

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Mr. Kroner failed to report millions of dollars in income received during the years 2005, 2006 and 2007 and like the majority of taxpayers seeking penalty relief under 6751(b) does not present a very sympathetic figure.  The revenue agent sent him a letter proposing to adjust his taxes to add in the millions of dollars he neglected to report.  In that letter the RA proposed penalizing Mr. Kroner for the oversight.  At the time of sending this letter, the supervisor had not approved the imposition of the penalty against Mr. Kroner though I doubt the RA was too worried about obtaining approval under these circumstances.  The supervisor did approve the penalty prior to the issuance of the notice of deficiency and long before the assessment.

At the time of this audit Frank Agostino had not yet educated the IRS concerning IRC 6751(b) and the IRS was not paying careful attention to supervisory approval whatever the “what” and “when” of the statute meant.  Mr. Kroner filed his petition in Tax Court in 2014 and not quite six years later in 2020 the Tax Court rendered its opinion in T.C. Memo 2020-73 upholding the tax deficiency and striking down the proposed IRC 6662 penalties for the years at issue due to the timing of the supervisory approval.

I do need to make brief mention that you know an opinion is well researched when it contains the citation “see also MICHAEL I. SALTZMAN & LESLIE BOOK, IRS PRACTICE & PROCEDURE § 10.01 (June 2022 ed.)”  Citing to the treatise that caused the creation of this blog does not make the opinion automatically correct but does indicate the court was researching in the right places.  The only thing better would have been a citation to the blog itself.  The opinion cites to the treatise in determining the meaning of assessment and uses that meaning in the first prong of its reason for holding for the IRS.

In rejecting the decision of the Tax Court, the 11th Circuit directly takes on the decision of “when” the supervisory approval must occur:

Essentially, the Tax Court reads the statute as follows: “No penalty shall be communicated to a taxpayer until such communication has been approved by the communicator’s immediate supervisor.”

We disagree with Kroner and the Tax Court. We conclude that the IRS satisfies Section 6751(b) so long as a supervisor approves an initial determination of a penalty assessment before it assesses those penalties. See Laidlaw’s Harley Davidson Sales, Inc. v. Comm’r, 29 F.4th 1066, 1071 (9th Cir. 2022). Here, a supervisor approved Kroner’s penalties, and they have not yet been assessed. Accordingly, the IRS has not violated Section 6751(b).

The Court gives three reasons for its decision and then follows up the brief statement of reasons with a more detailed discussion of year.  The brief statement is:

First, we think it is more consistent with the meaning of the phrase “initial determination of such assessment,” which is what must be approved. Second, we think it reflects the absence of any express timing requirement in the statute. And third, we think it is a workable reading in the light of the statute’s purpose.

Addressing the first of its reasons the Court states:

we are confident that the term “initial determination of such assessment” has nothing to do with communication and everything to do with the formal process of calculating and recording an obligation on the IRS’s books.

So, the Court takes a much different tack on the initial determination, the “what”, then taken by the Tax Court.  The Tax Court has focused on that phrase to determine that the first written communication to the taxpayer serves as the initial determination.  The 11th Circuit rejects that view giving the IRS much more time to get the supervisor on the scene but also giving the IRS much more time to use the penalty as a bargaining chip.  The concurrence comes in with a detailed explanation of why the Tax Court misses the right answer by focusing on what it thinks is the intent of the statute rather than on the language of the statute.

In describing its conclusion on the second point, the 11th Circuit states that the word “initial” describes “what must be approved and not when.”   The court applauds the IRS for now causing the approval to occur early in the process but says that the administrative position the IRS has adopted is not driven by the language of the statute because the word “initial” modifies ”determination of such assessment” and does not modify the phrase “no penalty under this title shall be assessed.”

The 11th Circuit then took on what it described as the “Tax Court’s communication-based pre-assessment deadline for supervisory approval.”  The 11th Circuit attributed the Tax Court’s approach to the approach taken by the 2nd Circuit in Chai – the first circuit court to review an IRC 6751(b) approval issue.  Because of the ambiguity in the phrase, “initial determination of assessment”, a phrase I think falls more into the meaningless or inexplicable category than the ambiguous category.  In trying to determine what Congress meant, according to the 11th Circuit, the Tax Court fell into the trap of looking at some of the legislative history which suggested the purpose of the statute was to keep the IRS from using penalties as a bargaining chip in reaching a resolution more favorable to the IRS than it might have reached without the threat of penalties.  The 11th Circuit explains why it doesn’t think this approach is correct.

The concurring opinion goes into even greater detail on why this approach by the Tax Court was a flawed approach.

As I have written before in describing this statute, I think any court will struggle to find the meaning of the statute in the words used by Congress since the words do not work.  Judge Holmes, whose concurring opinion in Graev is mentioned by the 11th Circuit, warned of the myriad of problems the statute could cause. I sympathize with the IRS to a certain extent because it has lost a number of penalty cases against taxpayers who deserve the penalties from which they were relieved.  My sympathy for the IRS is tempered by the fact it appears to have ignored the statute for the first 15 years of its life (causing cases like the Kroner case) and since being made aware of its responsibility by the litigation Frank Agostino initiated, the IRS has not written any regulations putting down a clear marker that could guide courts to a decision more favorable to the IRS.

With what appears to be a clear split in the circuits and a fair amount of money at issue, maybe Mr. Kroner will offer the Supreme Court the opportunity to parse the language of this statute.  Maybe the IRS will try again to obtain a repeal of this provision or maybe we will still be litigating Graev cases into the next decade helping to provide a never-ending source of blog posts.

Polish Lottery Winner’s Son Sues Over Penalties For Failing To Report Foreign Gifts

The other day I read in Tax Notes the complaint in Wrzesinski v US. I usually do not write about cases at this stage but it is a head scratcher.

Wrzesinski involves a refund suit for a hefty penalty under Section 6039F for failing to file Form 3520, the Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts.

Krzysztof Wrzesinski emigrated to the US from Poland in 2005 at the age of 19. About five years later his mom, who still lived in Poland, won the Polish lottery. She took the proceeds and made gifts to Krzysztof of $830,000 over the course of 2010 and 2011.

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According to the complaint, prior to receiving the gift, Krzysztof consulted an accountant who told him he did not need to file any forms with his tax returns and that the gift proceeds were exempt from gross income. 

Fast-forward about 8 years and Krzysztof, now a Philly cop, wants to make a gift to his godson. Searching the internet about consequences of that re-gift, he discovers that when he received the gift from his mom, he was supposed to file a Form 3520 to report the foreign sourced gifts.  In 2018, he contacts a Philly tax attorney for assistance with filing the forms and uses the “Delinquent International Information Return Submission Procedures.” As per those procedures, he explained in the submission his earlier reliance on an advisor and claimed that he had reasonable cause for failing to file the forms for both years. 

About a year later IRS assesses penalties anyway; $87,500.00 and $120,000.00 for 2010 and 2011. He files a protest, hoping to get the matter to Appeals. The protest gets lost in the system, and he gets TAS to intervene to get the matter before Appeals. 

About another year later Appeals abated $70,000 of the $87,000 penalty assessed for 2010 and $96,000 of the $120,000 penalty assessed for  2011. The Appeals write up indicated: “Case resolution based on ‘Hazards of Litigation’”; the remaining $41,500 in penalties was sustained.

Krzysztof paid the balance, and filed refund claims for both years. In denying one of the years’ claims the denial referred to the claim as “frivolous.”

Assuming the facts are as they are alleged (and they were properly before Appeals), and the taxpayer’s accountant was competent, I am struggling to see why Appeals did not fully concede.  The IRS had another chance to make this right when it considered the refund claim. Under Boyle and subsequent cases, reliance on an advisor that is premised on a mistake of law relating to the need to file a return at all differs from a nondelegable  duty as to when a taxpayer needs to file a return. And Appeals abated 80% of the penalty initially, an indication that it knew its position is shaky.

According to the IRS “[p]enalties exist to encourage voluntary compliance by supporting the standards of behavior required by the Internal Revenue Code.” I struggle to see how leaving thousands of dollars of penalties on the books for what seems like a good faith mistake based on what an advisor told makes any sense. Luckily for Wrzesinski, he was able to fully pay the balance of the penalties; otherwise Flora would have prevented him from bringing a refund suit. Of course, there is always the option of pursuing the initial advisor for malpractice, but that has costs.

Proposed Regs Address Access To Appeals

Last week the IRS released proposed regulations relating to the right to access the IRS Independent Office of Appeals. This comes in light of the Taxpayer First Act (TFA), which formally established the IRS Independent Office of Appeals “to codify the role of the independent administrative appeals function within the IRS.” 

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In addition to codifying Appeals and its mission statement, the TFA also added Section 7803(e)(4), which provides that “the resolution process [to resolve Federal tax controversies] shall be generally available to all taxpayers.” 

Access to Appeals, and when the IRS can cut off the general right to Appeals, has generated litigation, some of which we have discussed, such as last month’s 11th Circuit Affirms That Anti-Injunction Act Prevents Taxpayer Seeking Access to Appeals and in pre TFA times, such as Facebook Loses Challenge in District Court.

These proposed regulations address many of the issues that taxpayers have raised when seeking access to Appeals that for a variety of reasons IRS has not granted. On top of the statute noting that the right to Appeals is “generally” available, the preamble discusses the TFA legislative history showing that Congress was aware that IRS would be entitled to limit access to Appeals in certain circumstances.  One way that the proposed regs carve out some types of matters for Appeals consideration is by pegging access to Appeals only to a defined term, “federal tax controversies;” matters that do not implicate federal tax controversies do not trigger Appeals rights under the proposal.

The regulations specifically identify 24 categories of cases that do not trigger Appeals rights. Some of the major exceptions are listed below:

1. Frivolous Positions

2. Penalties Related to Frivolous Positions and False Information

3. Whistleblower Awards

4. Requests for a Taxpayer Assistance Order

5. Rejection of a Taxpayer’s OIC Submitted Under Section 7122 as Nonprocessable or No Longer Processable and Taxpayer Requests Appeals Consideration on the Basis that the OIC Should Be Deemed Accepted

6. Criminal Prosecution is Pending Against Taxpayer

7. IRS’s Automated Process of Certifying a Seriously Delinquent Tax Debt (passport revocation matters)

8.  Issues Barred from Consideration in CDP Cases

9. Authority Over the Matter Rests with Another Office (like Treaty competent authority cases)

10. Challenges Alleging that a Treasury Regulation is Invalid

11. Challenges Alleging that a Notice or Revenue Procedure is Invalid

12. Case or Issue Designated for Litigation or Withheld from Appeals

13. Appeals Issued the Determination that is the Basis of the Tax Court’s Jurisdiction

14. Challenges Alleging that a Statute is Unconstitutional

In addition to requesting comments on the scope and rationale for the newly proposed regulatory exceptions, IRS asks for comments on certain exclusions from Appeals review that are currently part of the IRM but not included in the proposed regs, including

  1. Denials of 9100 relief requests for an extension of time for making an election or other application for relief where the decision is reviewable by a court under an abuse of discretion standard and
  2. Denials of requests to change a taxpayer’s accounting method

The regulations identify other important issues, including requiring that the originating branch complete its action and reach a determination prior to a taxpayer’s access to Appeals; procedural and timing requirements that a taxpayer must meet before Appeals may consider the taxpayer’s Federal tax controversy; and a requirement that there is only one opportunity for Appeals consideration.

With respect to the originating part of IRS completing its actions, the proposed regs and preamble discuss a number of examples where access to Appeals is premature, including a deficiency case where the taxpayer for the first time requests relief from joint liability (query whether in that situation a remand to the centralized review unit should be appropriate, as Carl Smith discussed in Should the Tax Court Allow Remands in Light of the Taxpayer First Act Innocent Spouse Provisions? )

With respect to other timing requirements, the regs provide that the request must, as the preamble notes, be “submitted in the time and manner prescribed in applicable forms, instructions, or other administrative guidance and that all procedural requirements must be complied with for Appeals to consider a Federal tax controversy.” In addition, the regs note that there must be “sufficient time remaining on the appropriate limitations period for Appeals to consider the matter.” This is consistent with current IRM guidance, and proposes to elevate that guidance into regulatory rules.

With respect to the one opportunity/bite at Appeals rule, the preamble notes that “if a Federal tax controversy is eligible for consideration by Appeals and the procedural and timing requirements are followed, a taxpayer generally has one opportunity for Appeals to consider such matter or issue in the same case for the same period or in any type of future case for the same period.” The carve out also applies to taxpayers who failed to respond to an Appeals opportunity. There are important exceptions, including for CDP remands, taxpayers who participated in a variety of Appeals settlement programs like early referral and fast track settlement, and for taxpayers “who provide new information to the IRS and who meet the conditions and requirements for audit reconsideration or for reconsideration of liability issues previously considered by Appeals.”

Conclusion

I anticipate that the IRS will receive comments that will inform the reg drafters. Many issues lurk in the details, including nuances on the listed exceptions and other issues, including whether requests for Appeals access outside time provided in forms or other guidance should be subject to a form of administrative tolling. Comments on the proposed regulations are due by November 14; IRS has scheduled a public hearing on the regulations for November 29. Comments can be submitted via the Federal eRulemaking Portal at www.regulations.gov (indicate IRS and REG-125693-19). Old fashioned paper submissions are to be directed to CC:PA:LPD:PR (REG-125693-19), room 5203, Internal Revenue Service, PO Box 7604, Ben Franklin Station, Washington, D.C. 20044.

Tax Court Vacates at Least 40 Dismissals of Whistleblower Cases

In a 2020 unpublished order in Li v. Commissioner, Docket No. 5070-19W, the Tax Court held, on summary judgment, that the IRS whistleblower office (WBO) did not abuse its discretion in denying Ms. Li an award because she provided only vague and speculative information. She had alleged that the target taxpayer had filed false claims of rental income, dependent children, alimony paid, and mortgage interest paid for its 2016 and 2017 tax years.  A classifier in the WBO reviewed the target’s tax returns, found nothing amiss, and had denied Ms. Li’s claim in a final notice of determination. So, Ms. Li brought suit in the Tax Court under IRC 7623(b)(4).

The DC Circuit reversed the summary judgment decision, at 22 F.4th 1014 (D.C. Cir. 2022), because the circuit court determined that the Tax Court did not even have jurisdiction to hear the case.  I discussed the DC Circuit’s decision here.  The circuit court decision rests on the fact that the IRS never proceeded with an audit of the target taxpayer.  The Tax Court had thought it had jurisdiction of any final rejection of an award, no matter how early in the processes of the WBO.

Carl Smith has been following this case and has kept me abreast regarding what is happening in Li and in the Tax Court more generally, since a large number of WBO cases in the Tax Court involve threshold rejections like Li.

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On June 16, 2022, the Supreme Court received a pro se cert petition filed by Ms. Li, but the Court mysteriously did not promptly set up an electronic docket for the case. 

Ms. Li is a lawyer currently working at Stanford Law School, so her cert petition is much more lawyerly than most pro se petitions. In the petition Ms. Li argues that the Tax Court has jurisdiction to review threshold rejections of whistleblower awards under IRC 7623(b)(4), and that even if that statute doesn’t apply, the Administrative Procedure Act requires judicial review of threshold rejections by some court.  Here’s from the cert. petition:

[T]he D.C. Circuit held that the Tax Court lacks jurisdiction to hear appeals from threshold rejections of whistleblower award requests. Li v. Comm’r, 22 F.4th 1014, 1017 (D.C. Cir. 2022). But the fact that the Tax Court is precluded from hearing this instant appeal does not remove the statutory obligation to provide some form of judicial review of the WO final decision. If threshold rejections of whistleblower award requests are not reviewable by the Tax Court, then another court must have the judicial review authority. Take away judicial review entirely, and threshold rejections of whistleblower award requests are immune from judicial review.

The cert petition argues that there is a Circuit split, though, of course, only the D.C. Circuit can hear whistleblower award cases under IRC 7623(b)(4) and 7482(b)(1) (flush language).

On the understanding that the circuit court’s Li opinion had become final when the time to file a cert petition appeared to pass without such a filing, in July 2022, the Tax Court issued a number of orders in pending whistleblower award cases dismissing them for lack of jurisdiction because they involved threshold rejections of awards, similar to Li. 

On August 30, 2022, the Supreme Court belatedly created a docket for the Li cert petition.  The Tax Court became aware of the cert petition within a day or two after the Supreme Court had created the docket.

Concluding that the cert petition in Li was timely, the Tax Court decided to undo all the orders of dismissal it issued in July in Li and similar cases. One of the orders where the Tax Court vacated a prior dismissal, Essex v. Commissioner, can be found here. The other orders can be found on DAWSON.

There may be more to come, but as of the close of business on September 6, over three business days, the Tax Court has vacated 40 dismissal orders in whistleblower cases, including Li. I think it’s safe to assume that the Court is also holding onto any currently pending motions to dismiss these cases while it waits to determine if the Supreme Court will accept the case and then, if it does, how it will rule. This affects a substantial portion of the Tax Court’s whistleblower docket.  According to p. 19 of the Tax Court’s most recent FYE Budget Justification report, only 63 WB cases were filed in the Tax Court in FYE 2021. 

The Tax Court did not vacate recent dismissal orders in late-filed CDP cases when Boechler filed its cert petition.  Indeed, only after cert was granted did the Tax Court prospectively stop issuing orders in cases involving late-filed CDP petitions, pending the ruling by the Supreme Court on the merits.  As we have discussed in prior posts, after May 6, 2022, the Tax Court has also suspended the issuing of dismissals in cases involving late-filed deficiency proceedings pending the outcome of its decision in Hallmark, though the court has not vacated any earlier-issued dismissals of late-filed deficiency cases for lack of jurisdiction.  The Tax Court’s decision to vacate whistleblower dismissal orders merely at the time that the Li cert petition was filed may reflect an evolution of the Court’s views on undoing prior dismissal orders after what it had done in the CDP and deficiency cases.  It may, on the other hand, merely reflect a recognition that the number of jurisdictional dismissals in whistleblower case would only be a tiny fraction of the number of prior dismissals in CDP and deficiency cases.  For whatever reason, it’s a nice practice from the petitioners’ perspective.

The combination of the two groups of cases the Court is now suspending (i.e., Li-type and Hallmark-type cases) means that at some point the Court will have quite a few cases to work through in the future.  Still, this is a practice that protects petitioners and keeps them from having to file needless appeals or to lose their case while an issue of the Court’s jurisdiction is at play.