The rich really are different, and not just because they don't cut coupons. It often seems that they escape the rules that apply to the rest of us. Thus, there is understandable fascination when rich bad actors get a comeuppance. That is probably why so many folks blogged last week's decision about Wesley Snipes, where the Tax Court found that the Office of Appeals did not abuse its discretion in rejecting Snipes' OIC that would pay less than 4% of his $23.5 million tax liability. "Tax Girl" Kelly Erb put up this terrific post if you want the salacious details.
Today I want to look at a different bad actor, one just as rich as Snipes, albeit a bit less famous. The recent case of Daniel Sadek v. Commissioner, T.C. Memo. 2018-174 (Oct. 16, 2018), raises the question of whether the IRS is entitled to rely upon its records when sending an NOD to a rich and famous taxpayer who “everyone knew” had fled to Lebanon to ride out an FBI investigation.
In 2011 the IRS sent Mr. Sadek an NOD for over $25 million in tax deficiencies for the year 2005 and 2006. Mr. Sadek did not file his Tax Court petition until 2017. The IRS moved to dismiss because, it said, the petition was filed way after the expiration of the §6212 period to petition the Tax Court. Mr. Sadek also moved to dismiss because, he said, the NOD was not sent to his last known address. The IRS had sent the NOD to an address Mr. Sadek had left long before 2011.
The Tax Court indeed dismissed the case for lack of jurisdiction. But since the Tax Court might lack jurisdiction either because of an IRS screw-up (not properly sending the NOD) or because of a taxpayer screw-up (not timely filing a petition) it is important to understand which party messed up and why.
The case teaches a useful lesson about when and how the IRS can rely on its own records in order to meet the last known address requirement. I think Judge Goeke here got the right result, but I do question how he got there and so I offer what I (oh so modestly) believe is a better path.
Before the IRS can assess a deficiency of tax, the IRS must sent the taxpayer a Notice of Deficiency. §6212. Notably, the IRS need only send the notice; §6212(b)(1) says that an NOD “mailed to the taxpayer at his last known address, shall be sufficient” to satisfy the sending requirement. What constitutes a taxpayer’s last known address thus becomes important to know. The concept is regulated both by case law and by Treas. Reg. 301.6212-2.
The regulation gives the starting point. Subsection (a) says that “a taxpayer's last known address is the address that appears on the taxpayer's most recently filed and properly processed Federal tax return, unless the Internal Revenue Service (IRS) is given clear and concise notification of a different address.” The regulation then goes on to elucidate what tax returns count and what constitutes a properly processed return. Those are not issues in Sadek so I will skip them for now.
Suffice to say that the IRS complies with the statutory and regulatory requirements by sending the NOD to the address appearing on the most recently filed return, unless the taxpayer gave the IRS “clear and concise” notice. Courts, however, have said that when the IRS had some good reason to know that the taxpayer’s address had changed or that the address on the last filed return is invalid, the IRS must then exercise due diligence to figure out the correct address, even when the taxpayer has not given clear and concise notice. What constitutes due diligence is a facts and circumstances inquiry. See Keeton v. Commissioner, 74 T.C. 377 (1980); see also Taylor v. Commissioner, T.C. Memo 2016-81.
I think of the law, then, as creating two exceptions to the general starting point in the regulation. First, the IRS may not rely on the address on the last filed and processed tax return when the taxpayer explicitly tells the IRS to use a new address. Second, the IRS may not rely on the address on the last filed and processed tax return when the IRS gets information that suggests the address is invalid. In that situation, even though no one may have told the IRS the actual new address, the IRS must made a reasonable attempt to find the new address.
As to the first exception, Treas. Reg. 301.6212-2(a) tells taxpayers to read Rev. Proc. 90-18 or “procedures subsequently prescribed by the Commissioner” to see the rules for what constitutes clear and concise notice. The current relevant Rev. Proc. is Rev. Proc. 2010-16. The Rev. Proc. says that “clear and concise notification may be written, electronic, or oral.” It then goes on to list ways to do that. One way is filling out the proper IRS Change of Address Form 8822. But putting a new address on a Request for Extension Form 4868 is not sufficient. Nor is emailing the IRS clear and concise notice.
Importantly, clear and concise notice must be given directly to the IRS. The regulation specifically warns taxpayers that, with one exception, “change of address information that a taxpayer provides to a third party, such as a payor or another government agency, is not clear and concise notification of a different address for purposes of determining a last known address under this section.” (emphasis supplied). The exception is the U.S. Post Office. Treas. Reg. 301.6212-2(b)(2) says that a change of address form filed with the U.S. Post Office is clear and concise notice.
As to the second exception, the facts that trigger an IRS duty to engage in reasonable investigation are varied. The focus is on the information available to the IRS at the time it issued the NOD. Mulder v. Commissioner, 855 F.2d 208, 211 (5th Cir. 1988). For example, if the Post Office has returned other correspondence as undeliverable because the taxpayer has moved, that triggers the duty of due diligence. But if at the time it sends the NOD the IRS has no reason to believe the taxpayer’s address has changed from that used in the last filed return, then then IRS had no duty to go beyond the address on the last tax return. It is true that the Internal Revenue Manual Part 4.8.9, does instruct employees who receive back an NOD marked as undeliverable to search for a new address and, if they can find a new address and there is enough time on the assessment statute, to reissue the NOD to the newly found address. Details are in IRM 126.96.36.199. Remember, however, the IRM creates no duties enforceable in court. United States v. Caceres, 440 U.S. 741 (1979). If I am missing some case law that says an NOD returned undeliverable is per se invalid, I ask that someone share that in the comments. It would not be the first time I overlooked something!
Sometimes the duty of due diligence arises when a third party has information that the courts will impute to the IRS. For example, in Keeton the court held that the IRS failed to exercise due diligence when the NOD was sent to the address the married taxpayers had lived before they were convicted of tax evasion. What triggered the due diligence requirement there was that the IRS employee who sent the NOD had apparently been the one who made the criminal referral. Said the court:
“the Internal Revenue Service, an administrative agency of the U.S. Government, was inextricably entwined in the United States' investigation, prosecution, and conviction of petitioners for violation of the Federal income tax laws. Hence, they were on notice of petitioners' convictions, sentences, incarceration, and changes of address. *** In a factual setting such as we have here, respondent should not have simply sent the notice of deficiency to the last address in his files; reasonable care and diligence required him to at least inquire of Federal authorities as to petitioners' whereabouts after their convictions and sentences.” 74 T.C. at 383.
This proves important, I think, in Sadek.
In 2005 and 2006, the tax years at issue here, Mr. Sadek was rich and famous. He gained riches when his company, Quick Loan Funding, became a massive player in the sub-prime lending market. And while perhaps not famous enough for Wikipedia, Mr. Sadek famously lived a lavish lifestyle, including a passion for collecting very expensive cars. He was also famous, or infamous, as a movie director, exemplified by his 2007 self-financed vanity-project, the movie “Redline,” which has been called “the best worst car movie ever.”
When the sub-prime market crashed so did Mr. Sadek’s fortunes. He filed for bankruptcy protection on October 19, 2009. The case was eventually dismissed on April 24, 2012. Meanwhile, Mr. Sadek had moved to moved to Beirut, Lebanon in September 2010, apparently in response to the FBI opening an investigation on his lending company. He lived there until after the FBI closed its investigation, returning to the U.S. in May 2014.
The IRS sent Mr. Sadek an NOD on August 25, 2011, when Mr. Sadek was living in Beirut. It mailed the NOD to two address: (1) a California address that Mr. Sadek had used on his last-filed tax return, a return for 2005 that was filed on May 21, 2009; and (2) a Nevada address that was the address of record in the bankruptcy proceeding. Mr. Sadek did not file tax returns for any later year until August 28, 2014.
Mr. Sadek sought to contest the NOD by filing a petition with the Tax Court on January 4, 2017. The case was assigned to Judge Goeke. Mr. Sadek then moved to dismiss the case, arguing that the NOD was not properly sent. The IRS likewise moved to dismiss, arguing that Mr. Sadek filed too late.
Mr. Sadek conceded that the NOD was sent to the address on his last properly filed and processed tax return but argued that he had given sufficient notice of his change of address and that the IRS failed to exercise due diligence. First, he argued that the Bankruptcy case put the IRS on notice that neither the California nor the Nevada addresses were valid, because the Bankruptcy court ordered their foreclosure. Second, Mr. Sadek showed that during the time he was living in Beirut he had several conversations with an FBI agent involved in his investigation. Since The FBI knew where he was, he thought that should be enough to put the IRS on notice that it could not rely on his last filed tax return. Finally, Mr. Sadek argued that his own representative had told the Office of Appeals that he was living in Beirut and that communication was enough to trigger the duty of due diligence.
Judge Goeke rejected Mr. Sadek’s arguments and then dismissed the case because the petition was filed long after the 150 day period, even though that period was stayed by the bankruptcy automatic stay until, at the latest, when the bankruptcy case was dismissed in 2012.
Analysis: Two Wrong Turns Get The Court to the Right Destination
I think Judge Goeke gets to the right result, but he takes a curious pathway. First, he seems to hold that the IRS is always under a duty of due diligence, regardless of whether it is (or should be) aware that a taxpayer’s address has changed. He says that the IRS must always exercise “reasonable diligence in ascertaining the taxpayer’s correct address.” The IRS argued that it need only do that if it becomes aware that the address on file was invalid. Judge Goeke rejects that, writing: “We find no such triggering requirement in the standard.” Shucks, I do. Check out this explanation of the last known address rules given by the full Tax Court in the Keeton case:
“Normally, a taxpayer's last known address is that shown on his tax returns filed with respondent. Respondent is required, however, to use a different address if he learns or is advised by the taxpayers that the taxpayer has changed his address. Once respondent learns that a taxpayer is residing at an address other than the one shown on the return, he must exercise reasonable care and diligence in ascertaining and mailing the notice of deficiency to the correct address.” 74 T.C. at 372 (citations and internal quotes omitted).
Contrary to Judge Goeke’s understanding, I read that "once respondent learns..." language as indeed entitling the IRS to rely on the taxpayer’s address as shown in the last filed return, absent some triggering event by which “he learns or is advised...that the taxpayer has changed his address.” There is no requirement that the IRS always must independently verify the address shown on that last filed tax return. Judge Goeke’s contrary rule---that the IRS must engage in a due diligence search regardless of whether it has any reason to think that the address on the taxpayer’s last return is invalid---would place an intolerable burden on the IRS and runs counter to the both the regulation and to the standard as laid out by the Tax Court in Keeton.
Second, Judge Goeke seems to hold that the IRS can satisfy its due diligence obligation simply by consulting its internal records. Judge Goeke writes that “we are convinced that respondent exercised the appropriate level of diligence in seeking petitioner’s last known address.” For support he says that the IRS “could not have found petitioner’s last known address by merely searching his internal records.” I snorted when I read that word “merely.” The IRS has taxpayer records in over 140 discrete computer systems. Sure, some of them talk to each other, but some don’t. Searching internal records is a non-trivial task. That is why imposing a requirement that the IRS must independently verify the address shown on the last filed and processed return would be a huge burden.
Even so, this second rule that Judge Goeke appears to use---that the IRS need not search outside of its internal databases---also appears contrary to case law. Again, the Tax Court in Keeton certainly thought the IRS had a duty to go beyond its internal records. The IRS there should have consulted with the DOJ or FBI to see which prison the taxpayers had been sent to. The Keeton court held: “reasonable care and diligence required [the IRS] to at least inquire of Federal authorities as to petitioners' whereabouts after their convictions and sentences.”
I think the proper analysis, following Keeton, would be as follows.
Step one is to ask whether the IRS sent the notice to the address shown on the last properly filed and processed tax return from Mr. Sadek. It did.
Step two is to ask whether Mr. Sadek gave clear and concise notice of a change in address. He did not. Neither (1) the foreclosure notice in the bankruptcy case, nor (2) Mr. Sadek’s conversations with the FBI agent, nor (3) the Office of Appeals hearing met the regulation’s requirement because, none of those communications gave the actual new address Mr. Sadek was using. Judge Goeke concluded here that “petitioner provided no notification to respondent of a different address.” (emphasis in opinion).
Step three is to ask whether the circumstances triggered the duty of due diligence. That is, did the IRS have reason to know, at the time it sent the NOD that the address it used was invalid. Mr. Sadek’s claim was that the IRS knew he was in Beirut and they just failed to find out where. But there has to be some event that triggers the IRS duty to find that out. Here, that does not appear to have happened and, even if it had, the one IRS employee who got that notice appears to have responded reasonably. Let’s look at each of the three notices Mr. Sadek says the IRS received.
First, the bankruptcy court order may or may not have been enough to trigger a duty of due diligence. Judge Goeke’s opinion does not reflect when the order was issued. The timing here would be important to know. Certainly the order would not trigger the duty if it was issued after the IRS sent the NOD. Mulder. If the order had been issued earlier, then it might have triggered the duty, depending on circumstances. Bankruptcy cases are now generally worked by DOJ, not IRS Office of Chief Counsel. DOJ attorneys communicate with IRS employees in the Insolvency Units. So the order would have to have been issued in sufficient time for the information to get from DOJ to the Insolvency Unit to the Exam function handling the 2005/2006 audit or into the Individual Master File.
If the order were timely, it would be a trigger. Judge Goeke notes only that the order was not enough to be clear and concise notification. True that. The order merely lifted the automatic stay so that both the California and Nevada properties could be sold. It did not inform anyone of a new address for Mr. Sadek. But, hey, selling a property strongly suggests that property is no longer a valid address, so while the order would not be a clear and concise notification of a new address, it could still be enough to trigger the due diligence duty. That duty might involve no more than seeing if Mr. Sadek was the one who bought back the property at the foreclosure sale.
Second, Mr. Sadek’s conversation with the FBI agent was not enough to trigger the IRS duty of due diligence. While the Tax Court in Keeton did impute knowledge of a different government agency to the IRS, that was only because the IRS employee was intimately involved in the criminal case. Here, Mr. Sadek did nothing to show why the IRS should have known what the FBI knew, little as it was.
Third, as with the bankruptcy order, the notice given to the Office of Appeals may or may not have triggered the due diligence duty. Judge Goeke’s opinion is silent about the date of the Appeals conference. Assuming for a moment that the conference was in response to the August 2011 NOD, then obviously that would not trigger the requirement to go beyond the address on the last filed return. But if this was an Appeals conference held on some other matter prior to August 2011, then the declaration from Mr. Sadek’s representative that Mr. Sadek had moved to Lebanon might or might not trigger the duty. Based on the facts recited in Judge Goeke’s opinion, the representative simply said that Mr. Sadek was out of the country. That alone does not suggest that the U.S. addresses were invalid, just that Mr. Sadek was away from them.
If any of these three notices were actually enough to trigger the duty of due diligence, then I would agree that the IRS took reasonable steps to discover Mr. Sadek’s new address, but not for the reason that Judge Goeke seems to rely on. The key move here was by the Appeals Officer who repeatedly asked Mr. Sadek's representative for Mr. Sadek’s Beirut address. Mr. Sadek’s own representative replied that he did not know. He told the Appeals Officer that Mr. Sadek “had cut off contact with him.” That seems to me all the diligence that is due. It does not seem reasonable to require the IRS to go further when the taxpayer’s own representative confesses that he cannot reach his client.
Judge Goeke’s bottom line has the right idea: in this highly mobile world the burden should be on taxpayers to keep the IRS informed of where they can be reached. Judge Goeke writes: “Petitioner would have us impose an undue investigatory burden onto respondent and impute to him the knowledge of the entire Federal Government. We decline to do so.” I wholeheartedly agree with that sentiment but simply point out that Judge Goeke’s path creates some unintended but still undue investigatory burdens on the IRS and does so while at the same time removing potential protections for taxpayers.
Coda: “Tough times don’t last,” Mr. Sadek once said, “Tough people do.” I have a feeling the Tax Court will hear from Mr. Sadek again, in a CDP petition. I mean, for $25 million, you think the Mr. Sadek is not going to invoke CDP?? And when he does, the $25 million question will be whether he will be able to contest the merits of the liability. That will the subject of next week’s post.
Bryan Camp is the George H. Mahon Professor of Law at Texas Tech University School of Law.