Taxpayer Fails in Effort to Dismiss Erroneous Refund Suit

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In United States v. Sharpe, No. 2:20-cv-02490 (E.D. Pa. 2021) the court denied the taxpayer’s motion to dismiss an erroneous refund suit filed against her by the IRS.  The denial of the motion still leaves her with the opportunity to argue against the imposition of the erroneous refund provision on its merits.  It also provides an opportunity to look at the impact of prior litigation on the debt at issue in the erroneous refund action.

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In September of 2017 the IRS filed a notice of federal tax lien (NFTL) against Ms. Sharpe for unpaid taxes.  In response to the filing of the notice, she filed suit against the IRS in the Court of Common Pleas of Philadelphia County seeking to have the debt marked as satisfied and have the NFTL released.  The docket sheet in that case is available here. As it will almost always do and as it has the right to do, the IRS removed the case to the federal district court.  Only in very rare cases will the IRS leave a case in which it is a party in a local court.  The motion to remove is almost automatic.  While the IRS wants to litigate in federal rather than state court, depending on the cost of filing such a suit in state court, taxpayers suing the IRS might find a cheaper entrée to the court system by filing with the state court and letting the IRS remove the case to federal court.  This also slows the case down a bit.  I expect that most taxpayers suing the IRS in state court don’t really think too much about the filing fee or the speed but both could be factors in the choice of initial forum.

Another thing taxpayers may not think about, particularly pro se taxpayers such as Ms. Sharpe, is that if you sue the IRS in a matter like this, you also inevitably invite the counterclaim to reduce the liability to judgment.  While the IRS may not have otherwise brought a suit to reduce the liability to judgment, bringing an action such as this will trigger this response, potentially causing the taxpayer to leave the litigation worse off than before they brought it.  I have previously discussed the impact of the judgment here.

In Ms. Sharpe’s case against the IRS, in which the IRS did counterclaim for a judgment, the federal district court dismissed the case for lack of jurisdiction.  The IRS filed a motion for reconsideration, something it does not do lightly, and the court denied that as well.  I discuss motions for reconsideration here telling my own tale of woe on the subject.  I do note that this motion for reconsideration was filed by the Tax Division of the Department of Justice, which does not have the same internal rules for such motions that govern the IRS attorneys in Tax Court cases.  I suspect at the Tax Division the decision is left to the chief of the trial section, creating a lower bar for the filing of the motion than exists in a Tax Court case in which a Chief Counsel IRS attorney must go hat in hand to the National Office.  The district court denied the motion for reconsideration.

The government did not take the dismissal of its motion for reconsideration lying down.  It initiated an erroneous refund suit against Ms. Sharpe for the years 2014 and 2015.  She really had their attention now.  In the same suit it also sought to collect civil penalties against her for filing frivolous returns for five years and, in the alternative, to collect the tax and additions to tax assessed against her for 2014 and 2015.

The IRS alleged that Ms. Sharpe falsely overstated the amounts withheld on her 2014 and 2015 returns and received $452,803.89 in erroneous refunds.  First, this points out with a bigger exclamation mark why she should not have filed her original suit and stirred the hornet’s nest.  Second, this seems like a head scratching indictment of the IRS refund filters.  How could it let that much money out the door based on erroneous claims of withholding credits?

The dollar amounts in the balance of the case are equally eye popping:

The Government submits Defendant owes this entire amount, with accrued interest. (Id. at 8 ¶¶ 45-46.) Moreover, the Government asserts that Defendant remains indebted to the United States for civil penalties for the years 2012 to 2016 in the amount of $32,010.16, plus statutory additions and interest. (Id. at 9 ¶ 51.) Further, the Government avers that Defendant owes $54,479.08 in income tax for the year 2013. (Id. at 11 ¶ 57.) Finally, the Government pleads in the alternative to the claims set forward in Count I, that Defendant owes $72,427.33 for the year 2014 and $2,320,544.55 for the year 2015 for a total of $2,392,971.88, plus statutory additions and interest.

Ms. Sharpe argues that the court should dismiss the suit against her based on res judicata and collateral estoppel.  The court finds that it cannot because the first case did not result in a final judgment on the merits.  It states:

Issue preclusion is appropriate when:

1) The issue sought to be precluded is the same as that involved in the prior action;

2) The issue was actually litigated;

3) The issue was actually determined in a valid and final judgment; and

4) The determination was essential to the prior judgment….

Here, Defendant’s assertions do not meet the elements of either issue preclusion or claim preclusion. Defendant’s prior suit was dismissed for lack of jurisdiction. (Doc. No. 12 at 3.) The dismissal also set aside the Government’s counterclaim. (Id.) Thus, there was no adjudication on the merits of the counterclaim and the case did not end in a final judgment on the merits.

She also raised the issue of the improper service of the complaint; however, she failed to raise this issue in her answer and only raised it later.  On this issue it noted:

Federal Rule of Civil Procedure 12(b)(5) lists as a defense insufficient service of process. If a defense under Rule 12 (except for lack of subject matter jurisdiction) is not raised in an initial responsive pleading, the defense is deemed waived. Fed. R. Civ. P. 12(h)(1)(B)(ii). See also McCurdy v. Am. Bd. of Plastic Surgery, 157 F.3d 191, 193-196 (3d Cir. 1998) (holding that defense of insufficient service of process is waived if objections are not raised in the answer or pre-answer motion).

The court looked at its obligation to give pro se litigants a liberal construction of the rules.  So, it looked closely at her answer to see if anything there could support an argument that she did raise this issue initially.  It finds that nothing in the answer mentions or alludes to improper service.  It then goes on to look at the service and determines that the IRS made proper service.  One argument involved leaving the complaint with her 17-year-old son and the other involved the location of the service.  In both instances, the court found the IRS action proper.

Ms. Sharpe must now defend her erroneous refund case.  Based on the information in the denial of her motion to dismiss, it looks like she will struggle to successfully defend against the IRS.  I do not know what she might have done with the alleged erroneous payment of over $450,000 but my guess would be that unless she has saved this money in a bank account, a result I see as unlikely, or used these funds to buy property that has held or increased in value, a result I also see as unlikely but within the realm of possibility, the IRS may win the erroneous refund case but struggle to actually recover the money.  Ms. Sharpe provides a textbook example of why bringing a case against the IRS should be done only after careful consideration since it can result in significant negative consequences once the attorneys at the IRS and DOJ take a close look at the facts.  Better to stay much lower on the radar if you have this type of possible exposure.

Comments

  1. Bob Probasco says

    “this seems like a head scratching indictment of the IRS refund filters. How could it let that much money out the door based on erroneous claims of withholding credits?”

    The refund filters are *definitely* inadequate. There is a well-known tax protestor approach of filing returns, “correcting” the amounts on W-2 or 1099 to $0, and requesting refunds – not only of federal income withholding but also of Social Security and Medicare taxes witheld.

    The worst thing about letting those refunds out of the door is not the possibility the IRS won’t be able to recover the erroneous refunds. The worst thing is that the promotor of the frivolous scheme posts copies of those refund checks on his website. without (of course) mentionting that several of those “winners” had to not only pay back the refund but also pay significant penalties. And those copies of refund checks have a mesmerizing effect on taxpayers who stumble across the scheme and try it themselves. I advised one, at a virtual settlement day, and he refused to believe the scheme didn’t work. He didn’t necessarily understand all of the (frivolous) legal arguments but at a minimum he understood that the IRS had sent refund checks to a lot of people. Why would the IRS do that if the arguments weren’t valid? Inadequate refund filters + delays in audits + limited resources that limited the number of audits = a good explanation for tax practitioners. But it doesn’t necessarily convince taxpayers.

    (And in his case, if I remember correctly, the IRS *did* freeze his refund. I thought that they had fixed the problem, and maybe they mostly did, but it appears that there were still some big refund checks going out as recently as 2020 tax returns.)

    The IRS picks these up with the AUR program, but that doesn’t happen for quite some time after filing season. Realistically, they can’t delay *all* refunds until running AUR, as currently scheduled; there would be massive pushback from the government, probably a rare bi-partisan (and near unanimous) consensus. And with refunds going out over a long period of time, it may be too difficult or costly to run AUR a dozen or more times during filing season.

    I think strengthening the refund filters – for the notorious scams more than for inadvertent errors or mistakes as with EITC – should be a high priority.

  2. Steven Chung says

    Interesting find. I wrote about this as well at Above The Law. With attribution.

    https://abovethelaw.com/2021/11/suing-irs-tax-collectors-can-make-your-tax-debt-situation-worse/

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