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

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

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

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

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

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

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

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 Faced with a rescinded Notice, the IRS could not assess additional tax, and the taxpayer could not petition the Tax Court for review.

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

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

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

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

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

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

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

Prior Opportunity

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

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

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

Designation of Payments

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

About Patrick Thomas

Patrick W. Thomas is the founding director of Notre Dame Law School’s Tax Clinic, in which he trains and supervises law students representing low-income clients in disputes with the Internal Revenue Service. Prior to joining the law school faculty in 2016, he received an ABA Tax Section Public Service Fellowship to work as a staff attorney for the LITC at the Neighborhood Christian Legal Clinic in Indianapolis.

Comments

  1. Jerry Borison says

    With respect to the designation of payments to TFRP in bankruptcy, I worked with the bankruptcy attorney to get a provision included in the ORDER CONFIRMING AMENDED PLAN OF REORGANIZATION of the business that required all payments to be credited against the trust fund portion first. I was surprised the IRS did not object but that is what they are doing as my client makes payments.

  2. Lavar Taylor says

    Regarding the issue of “designating” payments made to IRS by a chapter 7 Trustee, my analysis is that the IRS is not free to apply the payments how it sees fit. Nor does the trustee have the ability to designate how payments are to be applied.

    Rather, payments must be applied in accordance with the distribution scheme in section 726 of the Bankruptcy Code. This scheme subordinates all claims for non-pecuniary loss penalties, even if these penalties are secured claims. Claims of a specific priority level are paid on a pro rata basis if there are insufficient funds to pay all claims in that priority level. Thus if total 507(a)(8) priority claims of the IRS total $100,000 and IRS receives a check of $50,000 from the trustee that should be applied to 507(a)(8) priority claims, the $50,000 payment should be applied pro rata among trust fund priority claims and non-trust fund priority claims.

    I’ve never seen a case adopting this methodology, but the IRS has never fought me on this in the very few cases where I raised this argument.

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