Lesson From The Tax Court: The Hotel California Rule

I love classic rock from the 70’s. Not just for all the great music, but for the way that the bands help me teach tax. For example, Fleetwood Mac teaches a lesson about §162 deductions for uniforms. I know, I know, you would think that lesson would come from the Village People, but it was Stevie Nicks who filed a petition in Tax Court after the IRS disallowed her deduction for stage clothing.

The Eagles’ classic “Hotel California” provides an excellent way to think about Tax Court procedure, as we can learn from the recent case of Daniel Sadek v. Commissioner, T.C. Memo. 2018-174 (Oct. 16, 2018).  In that case, the Tax Court dismissed as untimely Mr. Sadek’s 2017 petition contesting a 2011 NOD that the IRS had sent Mr. Sadek. The NOD was for $25 million and Mr. Sadek has not yet had a day in court to contest that amount. Oh, sure, he can sue for a refund but only if he fully pays the deficiency.  Flora v. United States, 362 U.S. 145 (1960). He could also file bankruptcy and ask the bankruptcy court to determine his tax liability under its powers in 11 U.S.C. §505. But Mr. Sadek’s best hope might come in a CDP hearing. That is what I want to explore in this post.

I think this case teaches a lesson about the relationship between the Tax Court’s deficiency jurisdiction and its CDP jurisdiction. The question is whether Mr. Sadek, who has now lost in Tax Court, will be able to contest the merits of the $25 million in a CDP hearing.  To answer that question, we need to understand the Hotel California rule and how it affects a taxpayer’s ability to turn what is ostensibly a hearing about collection into a hearing about tax liability.

Law

In most state courts, plaintiffs who file suit can leave any time they like by voluntarily dismissing their cases. In doing so they suffer no prejudice (unless it is a repeated dismissal). For example, Fla. Rules of Civil Procedure 1.420 allows a plaintiff to voluntarily dismiss at any time “before retirement of the jury in a case tried before a jury or before submission of a nonjury case to the court for decision.” Pino v. Bank of NY, 121 So.3d 23 (Fla. 2013). So when a plaintiff sees the writing on the wall, the plaintiff can scurry away to regroup and, perhaps, put on a better case next time.

In the federal system, Federal Rule of Civil Procedure (FRCP) 41 also permits a plaintiff to voluntarily dismiss a case simply by giving notice. This is the plaintiff’s right. Just as the plaintiff brings the case to life by filing a Complaint, the plaintiff can unilaterally kill the case per Rule 41. As explained in Janssen v. Harris, 321 F.3d 998, 1000 (10th Cir.2003): “The effect of the filing of a notice of dismissal pursuant to Rule 41(a)(1)(i) is to leave the parties as though no action had been brought. Once the notice of dismissal has been filed, the [trial] court loses jurisdiction over the dismissed claims and may not address the merits of such claims or issue further orders pertaining to them.” A first voluntary dismissal does not bar re-filing the same case later on (if the limitation period still permits), although if a plaintiff pulls the move a second time, it will preclude any future assertion of the same claim. FRCP 41(a)(1)(B).

The Tax Court is different. Once a taxpayer files a petition contesting an NOD, the Tax Court believes that it must, per this language in §7459(d), issue an opinion upholding or rejecting the proposed deficiency:

“If a petition for a redetermination of a deficiency has been filed by the taxpayer, a decision of the Tax Court dismissing the proceeding shall be considered as its decision that the deficiency is the amount determined by the Secretary. An order specifying such amount shall be entered in the records of the Tax Court unless the Tax Court cannot determine such amount from the record in the proceeding, or unless the dismissal is for lack of jurisdiction.”

Sure, taxpayers can check out anytime they like. Taxpayers often “check out” by failing to prosecute a case or by failing to respond to an IRS motion for summary judgment. That happens more often than you might think. Here are two recent examples: Castaneda v. Commissioner, T.C. Memo 2018-173 (October 16, 2018)(taxpayers failed to show up for trial); Stout v. Commissioner, T.C. Memo 2008-179 (October 24, 2018)(taxpayer failed to respond to IRS motion for summary judgment).

But they can never leave. Once a petition contesting a deficiency is filed, the Tax Court will issue a decision of some sort. In both the above cases, the Tax Court sustained the deficiency. Even the taxpayer’s death will not end the case. Duggen v. Commissioner, 21 B.T.A. 740 (1930)(sorry, no link). Nope. Once taxpayers file a petition, they are getting a decision from the Court, a decision that operates on the merits and precludes any further claims by the taxpayers on the years at issue, such as in a refund suit.

That’s the Hotel California rule: in a deficiency proceeding a taxpayer can never leave until the Court issues a decision on the merits, a decision that will stymie any future efforts to obtain a refund. See e.g. Brookbank v. Commissioner, T.C. Memo 1999-51 (no link, sorry!), aff’d 215 F.3d 1325 (6th Cir. 2000)(Table)

As with most rules, however, the Hotel California rule has exceptions. First, since it is derived from §7459(d) the Tax Court does not apply it to petitions that rely on other sources of Tax Court jurisdiction. See e.g. Davidson v. Commissioner, 144 T.C. 273 (2015)(stand-alone §6105(f) petitions); Jacobson v. Commissioner, 148 T.C. 68 (2017)(whistleblower petitions); cf. Schussel v. Commissioner, 149 T.C. No. 16 (2017)(applying Hotel California rule to §6901 petition regarding transferee liability).

The second exception is Tax Court Rule 123, which contains the Tax Court’s interpretation of §7459(d)’s last clause. Rule 123(d) says that a dismissal for lack of jurisdiction is without prejudice. That is, it does not bar future litigation on the merits of the deficiency asserted in the NOD.

That brings us back to Sadek.

Lesson: Effect of Tax Court Dismissal for Untimely Petition on Future CDP Hearing

As I discussed in last week’s blog post, the Tax Court dismissed Mr. Sadek’s petition for lack of jurisdiction because the petition was late. The IRS had issued its NOD (for $25 million) in 2011 during a time when Mr. Sadek’s bankruptcy case prevented the commencement of any court action. So the 90-day period was tolled until, at the latest, the automatic stay was lifted by the bankruptcy case’s dismissal.  That dismissal give the IRS permission to now assess the deficiency and then start collecting it.

When the IRS files its first NFTL for a given tax period, it must shortly thereafter give the taxpayer the opportunity for a CDP hearing. §6320. In addition, before the IRS can make its first levy, it must also give the taxpayer the opportunity for a CDP hearing. §6330.

During either CDP hearing, a taxpayer may challenge the underlying tax liability for a particular year if the taxpayer “did not receive any statutory notice of deficiency for such tax liability or did not otherwise have an opportunity to dispute such tax liability.” §6330(c)(2)(B).

Recall that CDP came into existence in 1998. When one looks at the last known address rule cases before then, one can see how the Tax Court was more willing to put a heavier duty of due diligence on the IRS precisely because deficiency proceedings were perceived as the taxpayer’s only shot at a pre-payment forum. For example, in Keeton v. Commissioner, 74 T.C. 377 (1980), the Tax Court held that the IRS had a duty of due diligence to ask other personnel in other government agencies for the taxpayers’ address when IRS personnel had recommended criminal prosecution of the taxpayers and thus should have known that the address on their last filed return was likely invalid....since they were in prison somewhere! Part of this holding comes, I think, from the court’s concern about prepayment forums. Said the court:

“We realize that the Internal Revenue Service is separate and apart from the Department of Justice which handles the Federal Government's criminal tax prosecutions. However, both are administrative agencies of the United States and work in conjunction in the enforcement of the internal revenue laws. We will not allow respondent to come into this Court wearing blinders and deprive petitioners, in these circumstances, of their only opportunity for a prepayment hearing to litigate their case.” 74 T.C. at 383 (emphasis supplied)

CDP creates (for some taxpayers) a new prepayment hearing opportunity. As I explained in more detail in this prior blog post, taxpayers who did not actually receive the NOD in time to file a timely petition can still get a pre-payment forum in which to contest the now-assessed tax liability in the CDP hearing process. See also Treas. Reg. 301.6320-1(e)(3), Q&A-E2. That is true even if the IRS properly sent the NOD to the taxpayers’ last known address. But taxpayers who want to do this still have to snag the opportunity for a CDP.

CDP is a pretty tricky opportunity to snag. That is one of many critiques I made about these provisions in this article from 2008. The only hard data I know of is a 2006 GAO study that found the IRS issued 2,276,684 CDP Notices in FY04 and further found that only 28,113 resulted in timely CDP requests. Folks, that’s about a 1% response rate. And I don’t think that low response rate is just because everyone agrees with the IRS decision to file an NFTL or start levying!

Applying the Lesson: Will Mr. Sadek be able to Contest Tax Liabilities in CDP?

It is not clear that Mr. Sadek will be able to actually contest his tax liabilities in CDP. The reason it is not clear is that we do not know from Judge Goeke’s opinion all the relevant dates we need to see whether Mr. Sadek actually received the NOD in time to file a timely petition.

Here are the dates we do know. Mr. Sadek filed for bankruptcy protection on October 19, 2009 and moved to Beirut in September 2010. The IRS sent the NOD to Mr. Sadek’s last known address on August 25, 2011, during the pendency of the bankruptcy case. Thus the automatic stay might have been in effect to prevent Mr. Sadek from filing a Tax Court petition. See 11 U.S.C. §362. If it was, it would toll the 90-day period to petition the Tax Court and then given him 60 more days on top of that. §6213(f). We don’t know exactly when the automatic stay’s prohibition on petitioning the Tax Court was lifted but it would be no later than when the bankruptcy case was dismissed on April 24, 2012. Mr. Sadek returned to the United States in May 2014.

Here is the date we do not know: when Mr. Sadek actually received the NOD. Mr. Sadek asserted to the Tax Court that “he did not become aware of respondent’s notice of deficiency until returning to the United States in May 2014.” If that is true, then he did not have an opportunity to contest the NOD because even using April 24, 2012 as when the automatic stay was lifted and even giving him the 150 days for being out of country at that time and the extra 60 days in § 6213(f), he was still out of time by May 2014.

But it also appears from Judge Goeke’s recitation of facts that Mr. Sadek did have an opportunity to contest the NOD and, in fact, did contest it before Appeals. Judge Goeke writes:

"Petitioner resided out of the country, in Beirut, Lebanon, when the notice of deficiency was mailed to him. Appeals Officer (AO) Laura Zhou was assigned to petitioner’s case, and petitioner was represented by Patrick McGinnis. During the pendency of petitioner’s appeal, AO Zhou and Mr. McGinnis communicated about petitioner’s location. Mr. McGinnis informed AO Zhou that petitioner was out of the country...and Mr. McGinnis represented to AO Ahou that petitioner had cut off contact with him as well.”

So this is a mystery. Judge Goeke does not say when AO Zhou was assigned to petitioner’s case and what case that was. If that was a non-docketed appeal of the NOD at issue here, then gosh and golly it sure looks like Mr. Sedak did indeed “otherwise have an opportunity to dispute such tax liability.” §6330(c)(2)(B). Even if he personally did not receive the NOD until May 2014, his minions did and they apparently tried to knock down the deficiency in Appeals. But if the referenced hearing was regarding some other NOD or some other matter, then that analysis would not apply. We just do not know.

Coda: While we don’t know all the relevant dates we do know that Mr. Sadek will likely be one of that 1% of taxpayers who properly trigger their CDP rights. He’s got good lawyers who know what to expect and will be ready for it. His attorney in Tax Court was Steven Ray Mather, who is co-author of the BNA Tax Management Portfolio "Federal Tax Collection Procedure-Liens, Levies, Suits and Third Party Liability" (No. 637). I would be quite surprised if Mr. Mather’s firm blows the CDP opportunity. So I would not be surprised to see another opinion regarding Mr. Sadek’s $25 million tax liability in about....oh....three or four years. Collection Delay Process strikes again! Unless, of course, Mr. Sadek succeeds in getting an OIC accepted.  With Mr. Mather’s savvy, that could also be a likely outcome here.

Bryan Camp is the George H. Mahon Professor of Law at Texas Tech University School of Law.