Paul L. Caron

Monday, September 11, 2017

Contesting Tax Liability In A Collection Due Process Hearing

Broadly speaking, tax administration (as currently structured) consists of two main functions:  determining tax liability and collecting the tax liabilities so determined.   There is, however, some overlap because taxpayers sometimes have the opportunity during the tax collection process to get a re-determination of the underlying tax liability.  The main opportunity comes in the Collection Due Process (CDP) hearing.  This is an administrative hearing conducted by the IRS Office of Appeals and is subject to judicial review by the Tax Court.   Two recent Tax Court cases — Mohamed v. Commissioner (TC Sum. Op. 2017-69) and Bruce v. Commissioner (TC Memo. 2017-172) — illustrate just how narrow this opportunity is for taxpayers.  To me, they teach the take-home lesson that the best shot taxpayers have at getting the most favorable result is to respond early and often to tax notices.  Taxpayers who wait are the taxpayers who cry.  For a lesson that Mohamed teaches about tax return preparer penalties see Les Book's great post here.  More below the fold.


Sections 6320 and 6330 require that before the Service can really start using its (still pretty awesome) administrative collection tools, it much give taxpayers an opportunity to ask for a CDP hearing.  While the focus of the hearing is on the appropriateness of using administrative collection powers, section 6330(c)(2)(B) permits a taxpayer to ask for a review of the underlying tax liability under certain narrow conditions.  First, if the taxpayer "did not receive any statutory notice of deficiency for such tax liability" then the taxpayer can contest the tax liability before the Office of Appeals and the Tax Court will review the Appeal's decision de novo.  But the Service makes a lot of tax assessments without being required to send taxpayers an NOD.  Notably the Service can often assess certain penalties without sending taxpayers an NOD.  You might think that since such taxpayers did not receive an NOD they could always contest liabilities during the CDP hearing.  Nope.  Sorry.  Congress took care of that by writing a second clause which reads "or did not otherwise have an opportunity to dispute such tax liability." 

Bruce illustrates the operation of the first condition for contesting a tax liability during CDP.  There the TP did not file a Federal income tax return for 2011.   But the Department of Defense sent in a 1099 for that year and, in September 2013 the Service asked Mr. Bruce to file his return or face an NOD.  Bruce did not respond.  In December 2013 the Service sent an NOD proposing to assess that amount (plus penalties and interest).  Mr. Bruce failed to take any action in response.   In February 2015, the Service proposed to start administrative collection.  Now Mr. Bruce responded!  He requested a CDP hearing.  At the hearing he wanted to argue that the DoD had mis-classified his income and it should not have sent the 1099.  The Office of Appeals refused to consider that issue and gave the Service the green light to collect.  Bruce appealed and the Tax Court said that because Mr. Bruce had received an NOD, then section 6330(c)(2) prohibited him from contesting the merits of the assessment in the CDP hearing. 

In contrast to Bruce, the taxpayer in Mohamed did respond.  Mr. Mohamed was a CPA who prepared returns for clients for the 2013 tax year.  In 2014, as part of the Service's earned income tax credit (EITC) due diligence audit program, a Tax Compliance Officer (TCO) reviewed 50 EITC returns Mr. Mohamed has prepared.  The TCO thought that for 20 of the returns Mr. Mohamed had failed to comply with the EITC due diligence requirements and so was subject to the return preparer penalty in section 6695.  The TCO proposed a $10,000 penalty ($500 per return).   Mr. Mohamed asked for and was given a review hearing by the Office of Appeals.  The Appeals Officer thought that 6 of the 20 returns were fine and so lowered the penalty to $7,000.  The Service assessed the penalty in August 2015 and in November 2015 proposed to start collection action.   Mr. Mohamed asked for a CDP hearing and, since the assessment of section 6695 does NOT involved an NOD, Mr. Mohamed tried to contest the liability determination of $7,000 at the CDP hearing.  However, this is where that second condition of section 6330(c)(2) kicks in, the condition that says a taxpayer may only contest a liability if the taxpayer did not "otherwise have an opportunity."  Here, since Mr. Mohamed DID have the opportunity to go to Appeals (and actually did so) to contest the liability, the Tax Court held that he could not take a second bite in the CDP hearing.  

If you want to read more about what "otherwise have an opportunity to dispute" means, you can find excellent discussion over at Procedurally Taxing.  But for me the lesson is that Mr. Mohamed successfully brought down his penalty from $10k to $7k by not ignoring his administrative appeal opportunities.  If, like Bruce, he had simply ignored those opportunities then he would have been hit with the $10k penalty and would still NOT have been able to contest it in the CDP hearing.

Bryan Camp, New Cases, Tax Practice And Procedure | Permalink


This part of § 6330 as interpreted by the regs (the statute itself doesn't say that a prior "opportunity" includes an Appeals hearing) and by the Service in practice is insidious. Among the reasons: (1) an Appeals hearing may be illusory, for example, where the issue is an Appeals Coordinated Issue, giving the hearing officer no leeway; and (2) the regs refer to "a prior opportunity for a conference with Appeals that was offered . . ." leading the Service to assert that the taxpayer is barred from challenging the merits in a CDP hearing once the Service has "offered" an Appeals hearing--for example, by issuing a 30-day letter--no matter how illusory the Appeals hearing, and even if the taxpayer has affirmatively rejected this illusory "opportunity" so that no hearing was ever held.

Posted by: Orrin Tilevitz | Sep 13, 2017 8:50:20 AM

Hi Chris, you are correct. However, the TP's burden in refund litigation makes district court, in my view, a less likely forum for favorable outcomes. First, realize that in refund litigation the taxpayer bears the burden of persuasion as to the correct tax liability. Lewis v. Reynolds, 284 U.S. 281 (1932). In contrast, when the TP is before the Office of Appeals, Appeals settles on hazards of litigation. I think it's easier to get Appeals to imagine losing a close case than it is to actually prove up a close case. But reasonable minds may well disagree with me on that.

Second, however, the TP has to actually have the resources to pay all the tax, penalties and interest (or, depending on the circuit, just the tax and assessed penalties and interest, or just the tax). The TP's only other hope is to dive into bankruptcy and let the bankruptcy court exercise its section 505 powers.

Posted by: Bryan Camp | Sep 12, 2017 10:03:44 AM

There is always the opportunity to pay the tax, penalties and interest and sue for a refund as well.

Posted by: Chris P. | Sep 12, 2017 8:57:11 AM