Source: https://procedurallytaxing.com/category/collection-due-process/
Timestamp: 2019-04-19 08:25:27+00:00

Document:
There were three designated orders for the final week of February 2019, and all of them concerned Collection Due Process (CDP) cases. Two of the orders (Savanrola Editoriale Inc. here and McDonald here feature the time-honored determination that it is not an abuse of discretion for the IRS to sustain a collection action when the taxpayer refuses to provide financial information or otherwise take any part in CDP hearing. The orders are not particularly novel in that regard, but they do provide a good contrast to the third order where the Court actually finds against the IRS and remands to Appeals.
Since abuse of discretion is a fairly vague standard, even the easy cases can be useful. Savonrola involves a taxpayer that wanted to challenge the underlying tax liability leading to the notice of federal tax lien (NFTL). However, apart from requesting a CDP hearing (blaming a faulty 1099-Misc for the liability) and then petitioning the court after receiving the determination sustaining the NFTL, it does not appear that the taxpayer engaged in the process much at all. The order does not reference any content from the CDP hearing itself, and it is not clear if the taxpayer engaged in the one that was offered. At the very least, the taxpayer does not appear responsive to the Tax Court once the petition was filed -the case was on the verge of being dismissed for failure to respond to an order to show cause. Because the taxpayer made no showing (and raised no argument) that they should be able to argue the underlying liability under IRC 6330(c)(2)(B) the Court had an easy time disposing of the case.
In McDonald the taxpayer did engage a bit more, but still not enough to give themselves a chance of winning on review. Here, the taxpayer apparently wanted to enter an installment agreement but had been unable to (which can happen to the best of us). However, the taxpayer had a back-year tax return that was “rejected” (that is, not-processed) by the IRS which complicated matters. At the CDP hearing, IRS Appeals was understandably unwilling to set up an installment agreement without that return being properly filed. Appeals also requested a Form 433-A for the installment agreement -the reasonableness of that request depending a bit more on the terms of the installment agreement being proposed. In response, the taxpayer sent an unsigned 2015 return and a Form 433-A lacking supporting documentation. When the signature and supporting documents were not forthcoming after multiple requests, Appeals rejected the installment agreement request and issued a determination sustaining the levy. As can be guessed, based on the failure of filing compliance alone, the Court had very little trouble finding there to be no abuse of discretion.
One can read the frequent, easy cases of Savonrola and McDonald to mean simply that the taxpayer will lose if they don’t comply with IRS requests during CDP hearings. But there is a deeper lesson to be learned: the Court needs something to look at to see how IRS discretion was exercised. By failing to comply or otherwise engage with the IRS during the hearing, you are building a record for review that can only ask one question: was it a reasonable exercise of discretion for the IRS to request the information in the first place? Almost (but importantly not always) the Court will find requests for unfiled tax returns or financial statements are not unreasonable and, by consequence, there was no abuse of discretion for the IRS to sustain the collection action when the requests were not complied with.
The important difference is that taxpayers may succeed even without providing requested information if they have readily engaged in the process. By so doing, they create a record for the Court to review and, possibly, come to a determination that discretion, properly exercised, would not require the information. The most famous of these cases is Vinatieri v. C.I.R.. In Vinatieri, the taxpayer provided a Form 433-A and demonstrated serious financial hardship and medical issues during the CDP hearing, but acknowledged that she had unfiled tax returns. The financial hardship was obvious, as was the fact that it would be exacerbated by levy. The IRS policy (that back year returns must be filed before releasing a levy under IRC 6343(a)(1)(D)) was not so obvious, and blindly following it was an abuse of discretion. Ms. Vinatieri was, it should be remembered, a pro se low-income petitioner with serious health issues. She is the prototypical taxpayer that CDP is meant to protect before disastrous levies take place. Nonetheless, it is not clear she would have prevailed (especially not in a “record-rule” jurisdiction) had she not engaged with the IRS at the hearing.
We’ve blogged briefly about Mr. McCarthy before. The case boils down to whether the petitioner or a trust is the real owner of two pieces of property. If petitioner owns it his collection potential should be upwardly adjusted and the IRS rejection of his Offer in Compromise (or partial pay installment plan) likely constitutes a reasonable exercise of discretion. The issue, then, is mostly legal: does the trust own the property, or is the trust merely the petitioner’s “nominee”?
When the issue before the Court is a question of law, the vagueness of “abuse of discretion” goes largely out the window. It is always an abuse of discretion to erroneously interpret the law at issue (See Swanson v. C.I.R., 121 T.C. 111 at 119 (2003)). McCarthy, however, involves a slightly different lesson: it isn’t necessarily that the IRS erroneously interpreted the law (thereby reaching the wrong determination). It is that the IRS didn’t sufficiently back up the determinations it did reach.
The IRS tried to determine whether the petitioner was the true “beneficial owner” of the properties in the trust by analyzing how the petitioner and trust actually treated the property. The first property at issue (the “Stratford” property) was rented out to a corporation (American Boiler) that was apparently controlled by the petitioner. American Boiler made rental payments to the trust for many years, though in apparently inconsistent amounts.
The IRS fares no better with the second piece of property (the “Charlestown” property). This time, the IRS inferences seem even more threadbare. The trust (with petitioner as trustee) purchased the Charlestown property. The IRS argues that it was “reasonable for [the Settlement Officer] to have inferred that the funds to purchase the Charlestown property must have come from petitioner.” Unfortunately, there are other beneficiaries (apart from petitioner) of the trust that may have led to other contributions to it, even aside from the aforementioned rental income the trust received. Accordingly, the Court finds no basis for the IRS determination that petitioner was the beneficial owner of the Charlestown property as well.
The point isn’t that the IRS was clearly wrong that the trust was not the nominee of the petitioner (it may very well be his nominee: he hasn’t exactly been a “good actor” in other tax matters –the first footnote of the order mentions his involvement in a criminal tax case). The point is that the IRS did not do its job in showing how they reasonably came to that conclusion apart from general inferences, which was the issue put before the Court. The taxpayer here may well be the polar opposite of Ms. Vinatieri: represented by counsel, likely affluent (at one time or another), and without the cleanest of hands. But like Vinatieri, (and unlike McDonald or Savonrola) they succeeded by engaging in the process and presenting a question (and record) the Court could reasonably rule in their favor on.
In Part I we focused mostly on summary judgment motions in deficiency cases, and particularly on how important it is to frame the issue as a matter of law rather than fact. The remaining designated orders of that week provide lessons on (1) burden shifting arguments, (2) state privilege and federal rules of evidence conflicts, and (3) arguments to raise (or not raise) in collection due process (CDP) litigation. We begin our recap with the latter.
Judicial review of a CDP hearing may sometimes seem a bit perfunctory -it can be difficult to make legal arguments in abuse of discretion review where the IRS appears to have quite a bit (though not unbounded) of discretion to take their proposed collection action. The statutes governing the usual “collection alternatives” (Offer in Compromise at IRC 7122, Installment Agreements at IRC 6159, and Currently Not Collectible at, more-or-less, IRC 6343) similarly do not provide a robust set of rules that the IRS cannot violate.
But that isn’t to say that judicial review in a CDP hearing provides no benefit. As I’ve written about before, CDP can be an excellent venue for putting the IRS records at issue -not asking the Court to rule on a collection alternative, but to prove that they followed the rules they are supposed to (proper mailing, supervisory approval, etc.). The statutory hook for these issues is the CDP statute itself -specifically, IRC 6330(c)(1) and (c)(3)(A). The orders discussed below rely (with varying success) on different statutory or common-law arguments.
The crux of Mr. Jackson’s argument is that the IRS didn’t balance these interests when they denied his installment request. Judge Gustafson (tantalizingly) mentions that there is a part of the Notice of Determination that specifically talks about the “balancing analysis” the merits of which the Court could review… but that, quite unfortunately, is not how Mr. Jackson frames the issue. Rather, the reference to the balancing test by Mr. Jackson is just a disguised, repackaged argument that the IRS should have accepted the proposed installment agreement.
There is good reason why it fails on that point. Namely, that Mr. Jackson was not filing compliant (he was delinquent on estimated tax payments) and the Tax Court has already held such a rejection not to be an abuse of discretion in Orum v. C.I.R. 123 T.C. 1 (2004). Since the crux of the argument is just “the IRS should accept my installment agreement” made twice (once as an issue raised under IRC 6330(c)(2)(ii) and once under IRC 6330(c)(3)(C)) it is doomed to fail.
Judge Gustafson refers to this language in the notice of determination when he writes “there was at least a purported balancing, whose merits we might review.” Emphasis in original. The present facts and posture of the case before Judge Gustafson leave much to be desired, but I wouldn’t bet against other cases potentially gaining traction on that line of argument. It is true that, in my quick research, petitioners historically haven’t had much success on “balancing analysis” argument. But many of the taxpayers in such cases were either non-individuals (i.e. corporate) see Western Hills Residential Care, Inc. v. C.I.R., T.C. Memo. 2017-98, non-compliant on filing, or the determination actually demonstrated the IRS did balance the equities, see Estate of Myers v. C.I.R., T.C. Memo. 2017-11. I’d like to see a case where the taxpayer legitimately raises such equity concerns in the hearing and the IRS determination blithely repeats the boilerplate language. I believe under those circumstances you may just have an argument for remand -particularly if the administrative record gives no insight to the Appeal’s reasoning such that abuse of discretion could be properly determined.
There is a lot going on in this case but, depending partly on your view of the validity of Treas. Reg. 301.6320-1(d)(2), Q&A-D1, the eventual resolution may seem inevitable. By breaking up the collection into two discrete issues (income tax vs. penalty) one can better trace the contrasting ideas of petitioner and the Court.
The taxpayer had a small balance due and was offered a CDP hearing after the IRS took their state tax refund (one of the few exceptions to a “pre-collection” CDP hearing: see IRC 6330(f)(2)). The taxpayer timely requested the CDP hearing. However, by the time the hearing actually was dealt with by Appeals it was moot because the balance (somewhere around $325 originally) now showed $0. Appeals issued a decision letter (erroneously but in this case harmlessly treating the original CDP request as an equivalent hearing) stating that there was no case because “your account has been resolved.” Nonetheless (and probably anticipating the next point), the taxpayer timely petitioned the court on that determination letter.
A little more than a month after receiving that decision letter, the taxpayer gets a new Notice for 2010, this time saying that she had a balance of $10,000. Only it wasn’t for any income tax assessment: it was a penalty under IRC 6038(b) for failure to disclose information to the IRS. The IRS issued a CP504 Notice for this penalty which, though frustratingly similar to a CDP letter (see Keith’s article here) will not ordinarily lead to a CDP hearing. Nonetheless, the taxpayer requested a CDP hearing (as well as a Collection Appeals Request) after receiving the CP504 Notice. Still later, however, the taxpayer did receive a Notice of Federal Tax Lien for the penalty conveying CDP rights, which they also timely requested. Most important, however, is just this: at the time of the trial no determination was reached and no determination letter issued regarding the penalty as a result of a CDP hearing.
If you are treating the matter as two discrete tax issues, the answer seems straightforward: dismiss for mootness. The only tax issue properly before the court (the income tax liability, not the penalty for which no CDP hearing or determination letter has issued) has a $0 balance. From that perspective, there is no real notice of determination or collection action to review.
Having their day in court, however, the taxpayer wishes to argue otherwise. Rather than dismiss for mootness, the Court should exercise jurisdiction by granting a motion to restrain assessment or collection because: (1) the case is not moot (the IRS says the taxpayer still owes a balance (penalty) for that year, after all), (2) the IRS previously said (in the Notice of Determination for the since-paid liability) that there was no balance due for that tax year and should be held to that under res judicata, and (3) there can be no further CDP hearings on this matter because the Treasury Regulation that (seems to) allow more than one hearing for a given tax period (Treas. Reg. 301-6320-1(d)(2), Q&A-D1) is invalid.
The Court basically says “no” to each of these arguments or premises. In reverse order, the Court says (1) it doesn’t need to touch the regulation validity argument because ta prior case that explicitly allows more than one CDP hearing per period (Freije II) doesn’t rely on the Regulation; (2) res judicata is not applicable to IRS determinations that are administrative rather than judicial in nature; and (3) the case is moot because the notice of determination before the court pertains to fully paid tax. The argument the taxpayer wants to make pertains to a penalty which has not yet even had a CDP hearing (or determination).
Lastly, we have the rare case where a taxpayer’s inaction (failure to fill out updated financial statements) is actually quite appropriate. In this instance, the case has been remanded to Appeals already, so court is waiting for parties to work things out. The IRS, as it often does, has since requested updated financial documents. But the taxpayer has not complied for the simple reason that it would be futile to do so: The determination of collectability, it appears, all circles around a legal question of whether a trust is the taxpayer’s nominee. Since the two parties are at loggerheads about that question, it is likely that will be a question for the Court and one of the reasons the judicial review of collection decisions can be important. Though, frustratingly for those of us working with low-income taxpayers, such wins seem to only appear to help those with trusts… See Campbell v. C.I.R., T.C. Memo. 2019-4.
There were two orders issued in the same day for the above case, and only the docket number was listed as “designated” (there was no link to a particular order) so I’m just going to treat both as designated orders, with greater detail on the more substantive of the two.
One of the orders (here) was a fairly quick denial of a summary judgment motion by the petitioner. The case concerns worker classification which, as Judge Holmes remarks, “is a famously multifactor test.” Generally, it is difficult to prevail in summary judgment on multi-factor (and highly fact intensive) tests. Here, the IRS disagrees with some of the “facts” (informal interrogatory responses) provided by petitioner in support of the motion for summary judgment. And that is all that it takes. Motion dismissed.
What is perhaps more interesting, however, is the accompanying order (here) that addresses who (petitioner or the IRS) has the burden of proof moving forward in this case. Those rules are pretty well set in deficiency cases, and the applicable Tax Court Rule 142(a)(1) also seems to make it an easy answer: the burden is on the taxpayer unless a statute or the court says otherwise.
There isn’t a direct statute on point. The most appropriate statute on point does not actually address the underlying type of tax at issue here: IRC 7491 burden shifting rules apply to income, estate and gift taxes but not employment taxes. Arguably, this could be interpreted as an intentional omission by Congress, such that there should be no burden shift with employment taxes. But, lacking a “direct hit” from Congress, might the taxpayer find some room for judge-made exceptions?
Here, the analysis goes to that most well-known of exceptions: the “naked assessment.” Judge Holmes quickly describes what appear to be two strains of naked assessment cases applicable to deficiency cases. The “pure” strain is a complete failure of the Commissioner to engage in a determination related to the taxpayer and completely ruins the validity of the Notice of Deficiency. This strain is derived from the well-known Scar v. C.I.R. case that taxpayers have rarely been able to use. The Scar strain actually won’t help petitioner, because he needs there to be jurisdiction in order to get court review of the employment status leading to the employment taxes (which are not subject to deficiency procedures).
Fortunately for petitioner, there is also a diluted strain of the naked assessment: the Portillo v. C.I.R. strain. The Portillo strain doesn’t ruin the validity of the notice of deficiency (thereby ruining jurisdiction), but simply removes the presumption of correctness. To get the Portillo outcome, you need to argue that there was a determination relating to the taxpayer, but that there was no “ligament of fact” behind that determination, and it should not be afforded a presumption of correctness. This is the judge-made exception the taxpayer wants here, and it certainly makes sense in omitted income cases (where the taxpayer has to prove a negative).
It appears that petitioner tries to get Portillo treatment by relying on a particular worker classification case, SECC Corp. v. C.I.R., 142 T.C. 225 (2014). In SECC Corp., both sides agreed that the Court didn’t have jurisdiction because the IRS didn’t issue its standard “Notice of Determination of Worker Classification” (NDWC) letter. Instead the IRS issued “Letter 4451” which both parties agreed (for different reasons) wasn’t a proper ticket to get into tax court. But the tax court found that they had jurisdiction anyway, because both parties were putting form over substance in contravention of the underlying statute’s (IRC 7436) intent. Essentially, the statute requires a determination by the IRS and the letter reflects the final determination: it doesn’t much matter what the letter is labeled and the legislative history buttressed the reading that a specific letter was not needed.
So why does the jurisdictional “substance over form” SECC Corp. case matter for petitioners here? It matters because they SECC Corp. never answered whether these “informal determinations” should be afforded the same presumption of correctness that a formal determination gets. And presumably, petitioner’s case is dealing with the same informal determination that SECC Corp. did.
Unfortunately, Judge Holmes isn’t buying that the SECC Corp. case created a new Portilla-style burden shift for worker classification issues. Petitioner has to point to something (statute or case law) that says the burden should shift. The only statute on point implies that it doesn’t. The only case(s) on point deal with notices of deficiency (SECC Corp. doesn’t speak one way or another on the issue). And so, with nothing to hang their hats on, they cannot prevail on the burden shift.
As far as Arizona state law goes, the department is correct on that point. Unfortunately, this is a federal tax case which, under IRC 7453 is governed by the federal rules of evidence, particularly FRE 501 which provides that federal law governs privilege questions in federal cases. And federal law in both the D.C. circuit and 9th Circuit (where the instant case would be appealable) make clear that no “dispensary – state” privilege is recognized.
Or, to parse, in conflict of state and federal law, Uncle Sam is the superior sovereign. Sorry Arizona.
Despite reaching the age of 20 this past July, CDP continues to create new issues for practitioners to learn and advocate. Twenty years ago I headed the project to write the regulation for the new CDP statute. Writing the regulation proved challenging because CDP was such a departure from federal tax collection practice to that point. As we have learned over the past 20 years, we failed to anticipate many CDP issues as we wrote the regulations and new issues continue to present themselves.
Over the course of 2018, we have written a number of CDP posts. I have collected the posts here. The issues are broken down into categories for ease of organization. Along with panelist Tom Thomas (who presided over the publication of the CDP regulations 20 years ago), Steve Milgrom, an attorney who is the Litigation and Volunteer coordinator for San Diego Legal Aid, and Scott Hovey, an attorney with the Washington, D.C. field office of Chief Counsel (IRS)(and an intern in the Richmond District Counsel’s office 20 years ago when I headed that office), I participated in a panel on the CDP developments in 2018 at a recent ABA Tax Section conference for low income taxpayers.
Perhaps the most remarkable feature of the presentation was that when we ran over our time, we were the last panel of the day, and the moderator went to stop the discussion the audience insisted that Steve finish telling his story of the Dang case. This is a case which he handled/continues to handle in which the IRS refused to levy on his client’s IRA in order to help the client by allowing the client to satisfy the tax liability without incurring the 10% excise tax under IRC 72(t). Steve’s persistent and effective advocacy for his client in that case resulted in the client paying tax due without having to pay a penalty for making the payment. Read more about the case in the link below if you missed it when we first wrote about that case.
Jurisdiction (The Petition) – If the taxpayer successfully requests a CDP hearing and Appeals decides to sustain the lien or levy, it will issue a determination letter giving the taxpayer 30 days within which to petition the Tax Court. If the taxpayer misses the 30 day deadline for a good reason, can the Tax Court accept the case based on equitable tolling or is the 30 day period to file the petition jurisdictional such that the Tax Court must deny the taxpayer entry into the court no matter how compelling the reason for late filing might be?
Starting the 30 day period – The taxpayer has 30 days to file the request or petition the Tax Court in a CDP case but when does that 30 day period begin? IRS letters do not always get mailed on the date on the letter. Many IRS employees flex and generate letters from their home which they do not print and mail until they come to work in the office on a later date. The date on the letter may be the date it was generated and not the date it was mailed. In the Weiss case the Revenue Officer dated the CDP Notice and took it to the taxpayer’s house; however, he did not personally deliver the notice as he had intended because the taxpayer had a large dog. The Revenue Officer mailed the letter two days later but the letter still contained the original date on which he had intended to effect personal service. The Tax Court decided that the date of mailing and not the date stamped or written on the letter that controlled.
Should Taxpayer Sign the Waiver Form Ending CDP – If the taxpayer reaches an agreement with Appeals, the Settlement Officer will ask the taxpayer to sign a waiver form terminating their CDP rights. While signing the form seems logical in some ways, what happens if the IRS does not follow the bargain you think you have struck? Would it be best to have the determination letter issued and go to Tax Court in order to get a more formal recordation of the agreement?
Standard of Review – When the Tax Court reviews the CDP case it generally reviews the issue de novo if the taxpayer contests the underlying liability and reviews for an abuse of discretion if the taxpayer seeks a collection alternative. If the taxpayer contests the application of a payment made by the taxpayer to the IRS, what is the standard of review for that contest?
Summary Judgment – When a taxpayer files a CDP petition in Tax Court seeking review of an issue decided on an abuse of discretion standard, Chief Counsel IRS frequently seeks to resolve the case by filing a motion for summary judgment. In seeking the motion for summary judgment, the government must follow certain steps and prove certain items. The Tax Court has criticized Chief Counsel attorneys regularly for seeking summary judgment without following the correct steps. How can you identify when you might have a defense to summary judgment based on the failure of the motion to include all necessary items?
TBOR and CDP – CDP is a natural place to argue the application of the Taxpayer Bill of Rights. It could apply to the balancing test. The IRS could be required to verify that its actions complied with TBOR. In the recent case of Dang v. Commissioner, taxpayer argued that requiring him to liquidate his IRA in order to pay the tax liability violated the TBOR provision that a taxpayer should pay no more than the correct amount of tax. The taxpayer argued that the IRS should levy on the retirement account in order to save the cost of the 10% excise tax under IRS 72(t). The Appeals officer who first heard the CDP case issued a determination letter saying that Appeals did not have the authority to grant the requested relief. When the case reached Tax Court the Chief Counsel attorney almost immediately requested a remand to Appeals to allow Appeals to make a determination based on the requested relief. The taxpayer opposed the requested remand as a waste of time but the Court granted the request and back in Appeals the relief requested by the taxpayer was granted.
There is another interesting TBOR case brewing in Tennessee, Freels v. Commissioner, Dk. No. 26674-17L. Petitioner, like the petitioner in the Dang case discussed in the link below, faced a motion to remand filed by the IRS when the IRS attorney realized that the position taken by Appeals and Collection would not result in an affirmation by the Tax Court of the position taken in the determination letter. Unlike the Dang case in which Judge Armen granted the requested remand, Judge Guy denied the remand in Freels in an order dated December 19, 2018. Mr. Freels’ counsel, Mary Gillum who directs the low income taxpayer clinic at Legal Services of Middle Tennessee and the Cumberlands, made arguments similar to the arguments made by Steve Milgrom in Dang. She argued that the IRS had failed to provide Mr. Freels with due process and violated his rights. While the underlying nature of the violation of TBOR in the Freels case differs from the violation alleged in Dang, the nature of the argument is similar. The Tax Court’s willingness to deny the remand and push forward for a resolution of the case (in taxpayer’s favor) may signal a new willingness to short circuit the dance back through Appeals to reach the right result and a victory for TBOR.
Seeking a Refund in a CDP case – The Tax Court position is that taxpayers cannot obtain a refund in a CDP case. Although the court issued a precedential opinion on this issue over a decade ago, it revisited the issue in some detail this year perhaps in anticipation of a challenge of the issue in the circuits.
Third parties and CDP – The IRS files nominee and alter ego liens and occasionally collects administratively from a third party. The IRS takes the position that third parties have no CDP rights. Third parties continue to push for some type of due process protection.
When is CDP case in Tax Court over – Because of the unlimited ability to have a CDP case bounce back and forth between the Tax Court and Appeals, an issue exists concerning the end of the case. At some point the Tax Court case concludes. When that time arises, anything further the Tax Court has to say does not matter.
Can the Settlement Officer in a CDP case take actions that would trigger an action for wrongful collection – Occasionally, the Appeals employee handling a CDP case will do something that the IRS believes violates their rights. If the action occurs during the CDP phase of the case, is that a collection phase such that the wrongful action gives the taxpayer a right to bring an action for wrongful collection or is the CDP process something different from collection action?
What is an administrative proceeding – A taxpayer can bring a CDP case to challenge the merits of a liability if the taxpayer did not have a prior opportunity to do so. The issue of prior opportunity implicates the ability to raise the innocent spouse issue as well. If the taxpayer can show that it did not have a prior administrative hearing in the innocent spouse context the taxpayer should have the ability to raise innocent spouse as a defense in a CDP hearing.
Gillette v Commissioner is a collection due process case arising from the tax consequences of prematurely withdrawing funds from an IRA and underpaying taxes while a taxpayer was suffering from compulsive gambling that she claimed was attributable to an addiction to prescription medication. The taxpayer sought an effective tax administration offer in compromise. While unsuccessful, the case warrants attention as there is very little law around this type of offer.
The opinion situates the sad tale that led to the sizable underpayment of taxes on her 2012 tax return. Ms. Gillette is a veteran and former firefighter who managed and owned a stable of rental properties. After retiring from firefighting, she developed a serious gambling addiction that she attributed to the side effects of pramipexole, a prescription medication.
Occasionally she would go days without sleep and at times slept in her car if she wasn’t given a complimentary night’s stay at a casino. Other times she would fall asleep at blackjack tables and slot machines only to be awakened by dealers and casino attendants. Nearly all of the money she collected from her rental properties went to casinos. When she ran out of money, she borrowed from friends and didn’t pay them back, took money and credit cards from her husband’s wallet, and eventually withdrew money from her retirement account in 2012.
In 2013, following the intervention of her son who recognized that the side effects of the medication she was taking were likely contributing to her gambling, she sought medical care to wean off the drug. Within a couple of years she was no longer taking the drug and was able to stop gambling. One lingering effect though was the 2012 alternative minimum tax (AMT) of about $17,000 and early IRA withdrawal penalty of about $10,500, both of which contributed to a tax balance due of almost $76,000 on her and her husband’s 2012 tax return.
Following a notice of intent to levy, the taxpayers requested a CDP hearing, challenging the underlying AMT liability and eventually offering $38,968 to compromise the liability based on effective tax administration (ETA). The ETA offer was sought because they were not a candidate for an offer based on doubt as to collectability, as the equity in assets (including the rental properties) exceeded the tax due (in fact Appeals determined that the reasonable collection potential in light of the assets was over $800,000).
The main part of the opinion dealt with Appeals’ rejection of the ETA offer and the Tax Court’s refusal to find any abuse of discretion in Appeals’ rejection.
The case originally went up to Tax Court a couple of years ago, but the Tax Court on the IRS’s motion remanded the case back to Appeals for a supplemental hearing because the original determination had an insufficient discussion of the reasons why Appeals agreed with the offer specialist’s decision to reject the ETA offer. By requesting a remand, the IRS avoided reversal for failure to consider the taxpayer’s equitable arguments. Guest blogger Professor Scott Schumacher previously discussed this requirement on PT.
After going back to Appeals, the settlement officer considered the taxpayer’s argument and again rejected the offer, in part on a finding that the side effect of the medications, including compulsive gambling, were known since 2006 and that the taxpayer made a choice to continue taking the medication anyway. In rejecting the offer on remand, Appeals did not refer the offer to the IRS’s ETA Non-economic Hardship Group, the group the IRM states should review ETA offers in “appropriate” cases.
If there are no grounds for compromise under paragraphs (b)(1) [doubt as to liability], (2) [doubt as to collectability], or (3)(i) [economic hardship] of this section, the IRS may compromise to promote effective tax administration where compelling public policy or equity considerations identified by the taxpayer provide a sufficient basis for compromising the liability. Compromise will be justified only where, due to exceptional circumstances, collection of the full liability would undermine public confidence that the tax laws are being administered in a fair and equitable manner. A taxpayer proposing compromise under this paragraph (b)(3)(ii) will be expected to demonstrate circumstances that justify compromise even though a similarly situated taxpayer may have paid his liability in full.
(1) a taxpayer with a serious illness requiring hospitalization for a number of years who, at the time, was unable to manage his or her financial affairs, including filing tax returns and (2) a taxpayer who learns after an audit that incorrect advice was given by the Commissioner and is now facing additional taxes and penalties because of that advice.
The main argument that the taxpayers made was that because of the drug use Ms. Gillette was mentally impaired and incompetent, essentially claiming that this was akin to an incapacitation that would justify acceptance of an offer below the collection potential.
Ms. Gillette and Mr. Szczepanski argue that their public policy or equity offer-in-compromise should be accepted because Ms. Gillette’s mental illness was caused by her prescription medication. While Ms. Gillette’s circumstances are unfortunate, Ms. Gillette and Mr. Szczepanski did not provide grounds for treating them differently from a similarly situated taxpayer who paid his or her liability in full. Their situation also differs from the examples given in the regulations: Ms. Gillette did not require hospitalization for a number of years, she was able to file her tax returns, she collected rents from her rental properties, and she did not receive incorrect advice from the Commissioner.
Finally Ms. Gillette and Mr. Szczepanski do not meet any of the compelling factors outlined in the IRM. Ms. Gillette was not so incapacitated that she was unable to comply with the tax laws, rejection of their public policy or equity offer- in-compromise would not have had a significant negative impact on their community, and their 2012 tax liability was not caused by an error or delay of the Commissioner or the fraudulent or criminal conduct of a third party.
This is a close case. No doubt the taxpayers come away feeling that the system did not adequately address their legitimate concerns. From a process standpoint, I feel their pain; the initial Appeals determination did little in explaining why the offer was originally rejected; on remand Appeals did not refer the case to the unit specifically that hears ETA offers (a point the opinion notes was not an abuse of discretion as the decision to do so is essentially one completely in Appeals’ wheelhouse); and at trial the Tax Court did not allow the testimony of the taxpayer’s doctor or VA social worker, among other witnesses.
I am not equipped to evaluate the level of the taxpayer’s incapacity or the degree to which the medication contributed to or caused the gambling that led to the liability and underpayment of taxes. It would seem to me, however, that the Tax Court might have benefited from the testimony of the doctor. While some circuits follow the record rule and limit review of CDP cases to the evidence in the administrative record, the Seventh Circuit, where the case is appealable, has declined to decide that issue. In addition, given the lack of guidance in this area, the IRM factors and examples have heightened importance, a curious result again from a process standpoint given the absence of any public input in their promulgation.
To be sure, as the opinion notes, and as the IRS emphasized, there is no explicit unfairness hook that would require the IRS to accept an ETA offer. In addition, the taxpayer has significant assets. Given the lack of case law in this area, it is likely that this case will be one that the IRS will lean on when taxpayers seek to resolve a liability even after a taxpayer makes a credible case that substance abuse has contributed to the taxpayer’s liability.
For readers interested in more on ETA offers, including suggestions on how the IRS can improve standards for evaluating the offers, check out Rutgers Law School Professor Sandy Freund’s 2014 Virginia Tax Review article Effective Tax Administration Offers-Why So Ineffective.
As discussed in three prior posts, the Tax Court issued two opinions in the Collection Due Process (CDP) case involving the Melaskys. In 151 T.C. No. 8 it issued a precedential opinion holding that a challenge to the crediting of payment is reviewed pursuant to an abuse of discretion standard and not de novo. In 151 T.C. No. 9 it issued a fully reviewed precedential opinion addressing the collection issues raised in the case before sustaining the determination of the Appeals employee and allowing the IRS to move forward toward levy. See our prior posts on the case here, here and here. In this third and final post on the second opinion, the issue discussed concerns the taxpayers proposed collection alternative. Even though the IRS rejected the taxpayers’ attempt to make a voluntary payment, they could still have reached an agreement had the IRS accepted their proposed partial pay installment agreement. The majority decided that the Appeals employee did not abuse his discretion in refusing to accept the proposed agreement.
From the prior posts you know that the Melaskys owe taxes for many years dating back to 1995. Over the years from 1996 until they filed their CDP request in 2011, they made various attempts to settle the debt through offers in compromise (OIC) and installment agreements (IA). When they filed their CDP request, they asked the IRS to give them a partial pay installment agreement. This type of IA allows the taxpayers to achieve a result similar to an OIC because it involves resolving the tax debt for less than full payment.
Appeals rejected the proposed IA because the Melaskys “have not paid over the equity in all of their assets” and because they declined to commit all of their monthly income to the IA. Either the failure to pay all assets or the failure to commit available income could provide a basis for rejecting the IA. The Tax Court concluded that Appeals had a sound basis based on both grounds. IRM 5.14.2.1 (March 11, 2011) provides that “Before a [partial payment installment agreement] may be granted, equity in assets must be addressed and, if appropriate, be used to make payment.” Generally, once the taxpayer gives the IRS all of their assets, the IA can be reached if the taxpayer will commit to paying the maximum monthly payment based on the taxpayer’s ability to pay taking into account the taxpayer’s necessary expenses and their income.
Before going into CDP the Melaskys had previously had two installment agreements. After meeting with Appeals in the CDP hearing, they were again told they had to provide the IRS with the equity in all of their assets. On December 2, 2011, they were given until December 16, 2011 to do this. By this point they had been in CDP 10 months. They came back on December 11 and said that they needed to use some of the assets to pay for the medical expense of their daughter. The Settlement Officer agreed to this as long as they provided proof and extended the time to provide payment from the assets until the first week of January 2012. On January 24, the Melaskys as for a further extension and the SO agreed while again requesting proof of the use of the funds for medical expenses. On February 9 they asked for another extension but this time they did not mention the need to use the funds for medical expenses. On April 4, the SO extended the deadline again to April 11. On April 20, 2012, the SO issued the determination letter and at that time the Melaskys still had not provided the equity in four of their assets: an IRA; a 401(k); a life insurance cash value and jointly owned stock.
The Tax Court found that in giving the taxpayers four and one-half months the SO gave them enough time to perform with respect to the assets and did not abuse his discretion in sending out the determination letter rejecting the IA. This is an unremarkable basis for sustaining a CDP determination.
With respect to the income side of the equation, the facts become more difficult because Mrs. Melasky had become the beneficiary of a trust under the will of her father. Based on the facts here it appears that her father died not long before petitioners made their CDP request. This raises strategy issues for individuals who stand to inherit property and who owe taxes. If you find yourself in that situation and you want to make a deal with the IRS either through an OIC or a partial pay installment agreement, you should strive to do so before the person dies. Her father’s death makes it hard for the Melaskys to get to the income number that they seek since the trust could provide funds for their support.
The court looked at the trust instrument and agreed with Appeals that it provided a source of funds which the IRS could use in calculating the Melaskys’ ability to pay a monthly amount to the IRS. The Melaskys disagreed with the IRS and the Court on this point but the Court goes through the trust document and determines what it allowed. If you represent someone with a trust who faces collection issues, you might the Court’s analysis helpful in deciding how much your client can pay.
As with the voluntary payment issue, Judge Holmes dissents. His dissent on this issue does not draw the same level of push back he received regarding his analysis of the voluntary payment issue but footnote 26 of the majority opinion does push back concerning the full payment issue. Judge Holmes again cites the Chenery rule because he finds that the majority have “saved” the SO by finding reasons for sustaining the determination that were not in the Appeals determination. Judge Holmes points out that partitioning the stock Mr. Melasky owned with his former spouse could have created real practical problems in terms of value. This is an issue that arises regularly when a taxpayer owns a partial interest in an asset of marginal value. How much effort and expense should the taxpayer expend to break free their fractional equity? Similarly with the cash value of the life insurance, its small value may have been outweighed by the fact it might cause the taxpayers to lose life insurance coverage altogether.
Because the SO did not consider, or did not record how he considered the difficulty in liquidation of certain assets, Judge Holmes would send the case back. On this point I think the taxpayers’ delays hurt them together with a failure to build out the record with proof of the difficulties. Judge Holmes makes good points about the difficulties with the two specific assets but the fact that the taxpayers changed their tune about the need to use the assets for medical expense and that after four and one-half months they still had not liquidated their IRA and 401(k) plans, something that should not take very long to do, left the taxpayers in a bad situation to defend against the decision of Appeals.
We have instead [instead of doing a full analysis of the intent of the trust document] a fact-intensive subsidiary (or “preludal”) legal issue that presented itself in a CDP hearing, before an SO incapable as a matter of training of deciding it as a trial judge would; and, more importantly, deprived of all the extensive and expensive fact finding weapons a trial judge could wield. This may harm taxpayers in some cases, while the lower cost of informal adjudication benefits them in others. It’s up to Congress to decide which is best; and here congress has opted for informal adjudication. That makes our review of such mixed questions an appropriate place to depart from the stricter standard that we would apply on purely legal issues. Doing so would also nudge us closer to the mainstream of administrative law.
In the end Judge Holmes states that he would not hold that the SO reached the right conclusion in deciding that the trust would allow the Melaskys to pay more money than they offer but that the SO “acted reasonably in answering this question and therefore did not abuse his discretion in rejecting the Melaskys’ proposed collection alternative on this ground. This makes good sense to me. Although it reaches the same result as the majority, I like this framing of the role of the Tax Court in these cases.
As discussed in two prior posts, the Tax Court issued two opinions in the Collection Due Process (CDP) case involving the Melaskys. In 151 T.C. No. 8 it issued a precedential opinion holding that a challenge to the crediting of payment is reviewed pursuant to an abuse of discretion standard and not de novo. In 151 T.C. No. 9 it issued a fully reviewed precedential opinion addressing the collection issues raised in the case before sustaining the determination of the Appeals employee and allowing the IRS to move forward toward levy. See our prior posts on the case here and here. In this second post on the second opinion, the issue discussed concerns the attempt to make a voluntary payment. The majority decided that the attempt fails leaving the taxpayers with outstanding debt on more recent, but still old, years.
The Melaskys owe taxes for many years dating back to 1995. Over the years from 1996 until they filed their CDP request in 2011, they made various attempts to settle the debt through offers in compromise (OIC) and installment agreements (IA). They had also made at least one designated payment of a lump sum to one of their more recent tax years.
On Thursday, January 27, 2011, the Melaskys hand-delivered a check for $18,000 to the IRS office in Houston handling their case, directing the IRS to apply the check against their 2009 income tax liability. On Monday, January 31, 2011, the IRS Campus Collection function in Philadelphia issued a levy to the same bank on which the check was drawn. The levy caused the bank to place a 21 day hold on their account and the hold occurred prior to the payment on the January 27th check.
Regular readers of this blog know that a taxpayer can make a voluntary payment and direct the IRS where to apply the check; however, if the IRS collects funds involuntarily the IRS can decide where to apply the levy proceeds and it does so in a manner that best protects the government. We have discussed the general issue of the voluntary payment rule here, here and here.
There are many reasons for a taxpayer to want to make a voluntary payment. In the employment tax context, a corporate taxpayer will almost always want to designate a payment to outstanding trust fund portion of the liability in order to protect corporate officers from the trust fund recover penalty found in IRC 6672. For individual income taxes such as the ones at issue here, taxpayers almost always want to designate payments to the most recent tax years, or the most recently assessed tax years, in order to obtain the possible benefit of older periods falling off the books due to the statute of limitations on collection or due to positioning for a bankruptcy petition in which the priority rules of bankruptcy will allow discharge of older tax years. Whatever was motivating the Melaskys, their strategy followed the normal pattern for taxpayers with multiple periods of outstanding tax liabilities.
The abnormal aspect of this case results from the timing of the levy vis a vis the voluntary payment. While I imagine that this fact pattern may occur in other cases, it would not occur often. The fact pattern also raises the question of whether the IRS sought to levy quickly after receiving a check in order to reorder the application of payments. The court addresses whether the voluntary submission of the check prior to the levy on the bank account permits the Melaskys to designate the application of the payment here or whether the fact that the payment to the IRS actually comes via the levy rather than the check allows the IRS to post the payment to the earliest outstanding liability.
On the same day that the IRS issued the levy to the Melaskys bank, it also sent them a CDP Notice for the years 2002-2003, 2006, 2008 and 2009. They timely requested a CDP hearing and subsequently petitioned the Tax Court upon receiving an adverse determination letter from Appeals. The Tax Court found two issues in the CDP case: (1) did the IRS abuse its discretion in not treating the check as a voluntary payment and (2) did the IRS abuse its discretion in rejecting a proposed installment agreement. Part 3 of this series will focus on the installment agreement aspect of the case while this post focuses on the voluntary payment issue.
The court notes that “a payment by check is a conditional payment because it is subject to the condition subsequent that the check be paid upon presentation to the drawee.” It also notes that delivery of a check does not discharge a debt. Anyone who has ever received a bad check can easily identify with that rule. If, however, a check is honored the payment relates back to the time of delivery of the check.
Here, the bank never honored the check because by the time it went to clear the account had no funds. Since the check did not clear, it could not constitute payment and since it did not constitute payment, any instructions regarding what to do with the payment because irrelevant. The court found that “taxpayers may direct the application of a payment only if payment occurs.” This seems like a rather straightforward application of the law but the petitioners want equity and not law. They argued that the Tax Court should create an equitable exception for situations in which the check does not clear due to that actions of the IRS.
On this point Judge Homes raises a vigorous dissent; however, he makes clear in footnote 6 that his dissent is not grounded in equity. One could almost get the feeling equity is a bad word here. As an aside, you may be wondering how Judge Holmes can even participate in a fully reviewed opinion since his term as an appointed Tax Court judge ended on June 29, 2018, causing him to assume senior status while Congress works through its amazingly quick appointment process to approve his reappointment. Because he is the trial judge in this case, he is allowed to participate in court conference on this case and to have his voice heard in the fully reviewed opinion.
Judge Holmes has concerns that the majority’s failure to create an equitable rule in this situation stems from the incredibly bad tax payment behavior exhibited by the Melaskys across the decades leading up to this opinion. On the point of his dissent, Judge Lauber writes a spirited concurring opinion in which he is joined by several judges. Judges Buch and Pugh write a narrow concurring opinion pointing out that on the facts of this case it appears the IRS followed all procedures but on similar facts it might be possible to find that the levy interfered with the attempted voluntary payment. All in all, the opinion gets very long because of the depth of the disagreement and the Tax Court shows more fractures in its personal relationships than we might normally observe. For this inside glimpse, you might read the entire opinion.
In footnotes, Judge Holmes raises interesting points about the IRS hitting the Melaskys with a bad check penalty. He expresses concerns about whether in doing so it followed the requirement of IRC 6751(b) to obtain proper approval and why it would impose such a penalty when IRC 6657 has a good faith and reasonable cause exception. It’s hard to imagine how this penalty would apply on these facts when they tendered payment with sufficient funds in the account and had no reason to know of the impending levy. Because the amount is small relative to the overall liabilities and maybe because of the timing of the imposition of the penalty vis a vis the CDP case, the Melaskys did not raise an objection to the imposition of this penalty. So, that issue will wait for another day.
Judge Holmes finds that the Appeals employee handling the CDP case did not provide an adequate explanation of the basis for concluding the payment did not meet the voluntary payment rules and, therefore, the court should remand the case. The primary concern raised by Judge Homes brings in the Chenery doctrine which binds the agency to the reasons expressed for its decision. He provides a detailed analysis of federal tax cases regarding the timing of application of payment when made by check. The concurring opinion does not spend much time addressing this collection of cases but focuses on Judge Holmes analysis of contract law and the interference the levy created with the ability of the Melaskys to complete performance of the payment of their check.
While Judge Holmes acknowledges that the parties had no express contract he points to the Melaskys’ reliance on Rev. Proc. 2002-26. He proposes a bright line rule that if the IRS causes a check to bounce the taxpayers should receive the benefit of the voluntary payment rule. The concurring opinion pushes back hard on the use of contract principles, the application of the Chenery doctrine in the way described by Judge Holmes and in the idea that the Appeals employee did anything wrong in making his decision. As always I learned a lot by reading Judge Holmes dissent but I am persuaded here that the majority got it right. Whether the IRS inadvertently caused the attempted voluntary payment to fail or the cause had been some third party, the failure of the check to clear keeps a taxpayer from gaining the benefits of the voluntary payment rule. As the concurrence points out, the Melaskys could have obtained a cashier’s check had they wanted to make sure the funds were in the account when the IRS sought to cash the check. That may be the greatest lesson for those seeking to make a voluntary payment and who want to avoid unpleasant surprises.

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