Alas! A closed Tax Court issued no opinions last week. Curse that federal shutdown! But the federal district courts did issue opinions. The Administrative Office of the U.S. Courts website says they have enough money (from fees) to run through January 18th. And their opinions teach lessons as well.
Today’s lesson comes from a lawsuit filed against the United States by Mr. Nicholas Morales, Jr. in 2017. He sued under §7433, a statute that gives taxpayers a cause of action against the government when any IRS employee negligently, recklessly, or willfully "disregards" any statute or associated regulation in title 26 “in connection with any collection of Federal tax.” His Complaint alleged that IRS employees had disregarded §7122 in refusing his Offer In Compromise.
The Federal District Court for the District of New Jersey has issued two opinions in the case: Morales v. United States (Morales I) on March 26, 2018 and Morales v. United States (Morales II) on January 2, 2019. Both opinions are marked “Not for Publication.” They are not, however, marked “Not for Blogging”! That’s a good thing because they actually make for a good basic lesson about the scope and limits of §7433. You will find the lesson below the fold.
Congress enacted §7433 as part of the very first statutory Taxpayer Bill of Rights (TBOR I) in 1988. It was part of the Technical and Miscellaneous Revenue Act of 1988, Pub.L. No. 100–647, 102 Stat. 3342. Section 7433 was one of 21 reforms that Congress made to tax administration. Here’s a GAO report on the IRS implementation of those TBOR I reforms.
As with many taxpayer protections §7433 promises much more formal relief than it delivers. While it may have a salutary informal effect on IRS operations, three significant limitations bedevil taxpayers who try to use it to recover damages for wrongful collection.
First, courts refuse to read the statute as allowing suits in connection with “determination” of taxes. The statute says “in connection with any collection.” Courts say that really only means post-assessment actions. It does not include assessment. See e.g. Miller v. United States, 66 F.3d 220, 223 (9th Cir.1995) (dismissing suit brought under §6433 for wrongful jeopardy assessment because §7433 did not apply to determinations of tax).
Second, the statute requires that taxpayers exhaust administrative remedies before they can sue. That means the taxpayer must properly file an administrative claim for damages directly with the IRS, per the instructions in Treas. Reg. 301.7433-1(e). Courts apply the exhaustion requirement strictly. See e.g. Gray v. United States, 723 F.3d 795 (7th Cir.2013) (dismissing taxpayer’s suit because she filed suit before filing the administrative claim that was rejected); Venen v. United States, 38 F.3d 100 (3rd Cir. 1994)(taxpayer’s protest letter to Revenue Officer that levy was in violation of ongoing installment agreement did not meet the exhaustion requirement even when RO had told taxpayer there were no further administrative remedies).
What is especially wicked about this second limitation is that the statute does not coordinate it with the two year limitation period that taxpayers have to file a §7433 suit. Treasury Regulation 301.7433-1(d)(2), however, cuts taxpayers a break in situations where taxpayers file their administrative claims within the last six months of the limitations period. It explicitly permits them to file suit without having to wait the otherwise applicable six months.
Third, the taxpayer must show that an IRS employee "disregards" some collection statute or regulation. Courts do not treat IRS employee violations of agency policies set out in the IRM or elsewhere as, standing alone, violations of statutes or regulations. Gonsalves v. Internal Revenue Serv., 975 F.2d 13 (1st Cir. 1992). Similarly, IRS employee actions that run counter to IRS publications are not actionable under §7433.; Gerstenberger v. IRS (D. Col. 2018), 122 AFTR 2d 2018-5744, 2018 WL 4357547 (taxpayer allegations that IRS employees violated procedures set out in IRS publications failed to state §7433 claim)(no publicly available copy).
Unlike most Tax Court dispositions, this case has no findings of fact, whether based on stipulations or trial. In both Morales I and Morales II, District Court Judge Brian Martinotti assumed that all the facts in Mr. Morales Complaint were true. He then decided that, even so, Mr. Morales---at all times proceeding pro se---had not stated a claim on which relief could be granted and dismissed the case. Each opinion allows Mr. Morales some time to amend the Complaint before the court enters judgment.
Here are the facts alleged in Mr. Morales’ first Complaint.
(1) On an unknown date, Mr. Morales submitted an OIC for $100.
(2) On November 12, 2015, the IRS sent Mr. Morales a Notice of Determination denying his OIC. The grounds given in the denial were that he had the ability to pay the liability in full, and that he was not in current compliance with tax filing and payment obligations for later tax periods.
(3) On March 29, 2017, Mr. Morales filed his §7433 lawsuit, alleging that the IRS had wrongfully rejected his OIC.
In Morales I Judge Martinotti granted the government’s Motion to Dismiss because no allegations in the Complaint showed compliance with the administrative exhaustion requirement. The Court gave Mr. Morales time to amend the Complaint before entering judgment.
Mr. Morales then submitted this additional allegation which the Court treated as an amendment to the Complaint:
(4) On March 22, 2017, Mr. Morales sent a letter to the IRS complaining it had violated §7433 in denying his OIC.
You can see how this allegation cures the defect, at least enough to pass a Rule 12(b)(6) motion to dismiss. It alleges an administrative claim submitted within six months of the limitation period’s end. That means Mr. Morales did not need to wait until he received a response before filing suit. Treas. Reg. 301-7433-1(d)(2).
The government once again moved to dismiss. In Morales II, the court granted the motion. This time, the court decided that the Notice of Determination denying the OIC did not disregard any relevant statute. It noted that the relevant statute was §7122 and that statute gave the IRS “purely discretionary” authority to accept or reject OICs. Section 7433 only permits suits for disregard of a collection statute, and an allegation that a Notice of Determination rejected an OIC could not, therefore, be an allegation that the IRS disregarded §7122.
I take away two lessons from this case.
First, if you have the choice, file the §7433 administrative claim when there is less than six months left in the two year limitation period. Otherwise, you must set a tickle reminder for six months to remember to file suit. For example, if you file the administrative claim eight months before the limitation period ends, then you potentially have only a two month window to file suit. Worse, if you file six months and one week before the limitation period ends, you must be really quick to get that Complaint filed within your remaining one-week period to file suit. So when you are that close to the six month mark before the end of the two year limitation period, the lesson here is just wait until you get to within six months. Then you can file the administrative claim (carefully following the regulation!) and file your suit the very next day. That's all thanks to Treas. Reg. 310.7433-1(d)(2). I welcome comments about that idea.
Second, you gotta have a duty to hang on the IRS. You need a statute or regulation that actually has a requirement before you can successfully allege a disregard of that requirement. So the lesson is that this case did not turn on whether §7122 was or was not a collection statute. Judge Martinotti instead decided that §7122 was “purely discretionary” and thus contained no requirement that could be disregarded.
One might well question whether the rhetoric outran the facts of the case. For example, in Addington v. United States, 75 F. Supp. 2nd 520 (S.D.W.Va. 1999) the court there declared that “even if the IRS had summarily rejected plaintiffs’ [OIC], it would not give rise to a claim for intentional or reckless violation of the Code."
I’m not so sure. I think §7433 might well reach §7122. Section 7122 imposes duties. To be sure, it imposes no substantive duties to accept any OIC. But it appears to impose plenty of process duties. Just as the IRS’s discretion to levy is not unbounded, neither is the discretion to accept or reject OICs. Contrary to the Addington opinion, I suspect that an allegation the IRS had arbitrarily denied an OIC would survive a Motion to Dismiss. In Morales I and Morales II, however, there was no credible allegation that the IRS Notice of Determination was arbitrary. Mr. Morales was just upset that his $100 mini-offer had been rejected.
Coda: I have to wonder why Judge Martinotti strung poor Mr. Morales along. After all, Mr. Morales’ first Complaint was pretty specific that he thought the IRS had wrongfully rejected his OIC. So it was a waste of everyone’s time to dismiss that first Complaint for lack of exhaustion when, even if there was exhaustion, the Complaint still failed to state a valid §7433 claim. I can only assume that Judge Martinotti was not familiar with §7433 (and why would he be?) and the blame for that lies at least partially on the Department of Justice attorney who apparently did not bring this to the Court’s attention the first time round.